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Full text of "Fundamentals Of Accounting"

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FUNDAMENTALS 

OK 
ACCOUNTING 



FUNDAMENTALS 

OF 
ACCOUNTING 



ROBERT A. FAMBFRTON, M.A.,C. P. A. 

ASSISTANT!' PROFESSOR OF ACC< )U N'l i \C, KFKiEKS IMYEKM'IY 

NEW BRUNSWICK, \. f. 

MEMBER OF THE FIRM OF KFA, LAMBERTON cV CO. 
CERTIFIED PUBLIC ACCOUNTANTS 



LONGMANS, GRKKN AND CO. 

NEW YORK LONDON * TORONTO 
I _L 2 



LONGMANS, GREEN AND CO. 

55 FIFTH AVENUE, NEW YORK 
221 EAST 20TH STREET, CHICAGO 



LONGMANS, GREEN AND CO., LTD. 
OF PATERNOSTER Row 

43, ALBERT DRIVE, LONDON, S.W. 19 
17, CHITTARANJAN AVENUE, CALCUTTA 

NICOL ROAD, BOMBAY 
36A, MOUNT ROAD, MADRAS 



LONGMANS, GREEN AND CO. 

215 VICTORIA STREET, TORONTO 



LAMBERTON 
FUNDAMENTALS OF ACCOUNTING 



COPYRIGHT -1938 
BY ROBER/T A. LAMBERTON 



COPYRIGHT . 1942 

, GREEN AND CO., INC. 



ALL RIGHTS RESERVED, INCLUDING THE 
RIGHT TO REPRODUCE THIS BOOK, OR 
ANY PORTION THEREOF, IN ANY FORM 



PRINTED IN THE UNITED STATES OF AMERICA 



PREFACE 

Another new text, embracing the fundamentals of Account- 
ing! Why? 

An exclamation and a question and why shouldn't the 
teachers ask such a fair question? In the same fairness I should 
like to write this preface as a personal note to all teachers of 
accounting, and trust that after reading it they may feel too that 
there is a need and a place for another new accounting text. 

About twelve years ago I had in mind the preparation of a 
text which would present the principles of accounting in a sim- 
ple, clear, concise manner. In 1929 I had copyrighted and pri- 
vately printed, Fundamental Principles of Accounting. The 
text was intended primarily for my own use at Rutgers Uni- 
versity, in the College of Arts and Sciences, but was used also 
by my colleagues in the evening classes of the Extension Divi- 
sion, in both New Brunswick and Newark. In 1934 the text 
was revised and enlarged and was privately published in multi- 
print for use in both the day and evening divisions of Rutgers 
University, and several junior colleges in New Jersey. 

From this use, extending over a period of twelve years, by 
some ten or more instructors, who presented the materials to 
many thousands of students, much valuable new material has 
been compiled. With this wealth of new material and experi- 
ence, together with valuable suggestions from students and con- 
structive ideas from my teaching associates, it has been a pleas- 
ure to prepare this text. It will be observed, therefore, that the 
text is not an experiment, but rather the perfection of an idea 
which originated several years ago. 

It is my firm belief, after all this experience, that the first- 
year course in accounting for schools of college grade should 
be limited to the fundamentals of accounting; that these should 
be a combination of theory and practice; that each topic 
should be thoroughly understood before another more advanced 
topic is studied, and that it is much better to have a limited 
amount of carefully selected material really mastered by the 
student than to have a great deal more material presented than 
the most advanced student would have any hope of mastering. 

In order to carry out this program it was first necessary to 

T 4 V^viT v 



vi PREFACE 

decide upon a logical order of presentation, so that each new 
topic would fit into the unified whole by utilizing the material 
which had gone before. A second problem was to select care- 
fully the topics which we felt would be best suited for an ele- 
mentary text. Topics were included which the majority of 
instructors consulted felt belonged in the first-year course, 
while those we felt more properly belonged to advanced ac- 
counting, cost accounting, or auditing were omitted. We did 
not believe a six- or seven-hundred page text necessary. 

Fundamentals of Accounting may be used equally well as the 
basic text in courses planned for general students or for the 
accounting major. It has been used successfully by both 
groups. To make this possible, more than ample practice 
problems and theory questions have been geared to the text 
and placed at the end of each chapter. For optional use a fur- 
ther unified three-unit practice set is provided at the end of the 
book. The set is so constructed that any unit may be used 
alone. For general students it is suggested that less emphasis be 
placed on the problems, while the accounting majors should, 
if possible, have an accounting laboratory, where all problem 
material may be covered with a stronger emphasis on technique 
and the business-like presentation of accounting solutions. In- 
structors using the text will be provided with a solutions manual. 

I trust Fundamentals of Accounting may be found useful 
by many teachers and students. I should welcome any criticism 
or suggestions for improving the text for use in future editions. 

It is a distinct pleasure at this time to thank all those who 
helped make this book possible, particularly the students and 
my teaching associates who used the book in its preliminary 
form. All this assistance has been helpful and encouraging in 
writing the book. 

ROBERT A. LAMBERTON 



CONTENTS 

CHAPTER PAGE 

I. INTRODUCTION i 

II. THE BALANCE SHEET 8 

III. THE PROFIT AND Loss STATEMENT 26 

IV. THE LEDGER, ACCOUNTS, AND THE TRIAL BALANCE . 41 
V. FUNDAMENTALS OF DEBIT AND CREDIT .... 54 

VI. THE GENERAL JOURNAL AND BUSINESS PAPERS . . 70 

VII. NEGOTIABLE INSTRUMENTS AND BUSINESS PAPERS 

(concluded) 92 

VIII. SPECIAL JOURNALS 115 

IX. SUBDIVISION OF THE LEDGER AND CONTROLLING 

ACCOUNTS 131 

X. ACCOUNTING AT THE END OF THE FISCAL PERIOD . 152 

XI. ACCOUNTING AT THE END OF THE FISCAL PERIOD 

(continued) 168 

XII. ACCOUNTING AT THE END OF THE FISCAL PERIOD 

(continued) 187 

XIII. ACCOUNTING AT THE END OF THE FISCAL PERIOD 

(concluded) 212 

XIV. PARTNERSHIP ACCOUNTING (INTRODUCTION, 

FORMATION, AND DIVISION OF PROFITS) . . . 229 

XV. PARTNERSHIPS (ADMISSION OF A NEW PARTNER 

AND DISSOLUTION) 257 

XVI. CORPORATIONS ORGANIZATION 276 

XVII. RECORDS AND ACCOUNTS PECULIAR TO THE CORPORA- 
TION 33 

XVIII. THE THEORY OF CORPORATIONS APPLIED . . . . 331 

vii 



viii CONTENTS 

CHAPTER PAGE 

XIX. DEPARTMENTAL ACCOUNTING AND COLUMNAR 

JOURNALS 346 

XX. ACCOUNTING FOR THE MANUFACTURER . . . . 372 

XXI. THE VOUCHER SYSTEM 390 

XXII. PAYROLL ACCOUNTING AND THE SOCIAL SECURITY 

PROGRAM 410 

XXIII. ANALYSIS AND INTERPRETATION OF FINANCIAL 

STATEMENTS 425 

COLLEGE BOOK SHOP PRACTICE SET 451 

INDEX 463 



FUNDAMENTALS 

OF 
ACCOUNTING 



FUNDAMENTALS OF ACCOUNTING 



CHAPTER I 
INTRODUCTION 

As the student starts a new course, many questions probably 
run through his mind; briefly he wonders what it is all about. 
With this thought in mind, it may be well to present a few ideas 
regarding the subject about to be studied. 

Record keeping is almost as old as man himself. In the 
archives of history may be found many well preserved records 
of accounts going back many, many years. It will not be neces- 
sary, nor would it be profitable for our present purpose, to trace 
the development of bookkeeping and accounting down through 
the years. Modern accounting, now a well recognized science, 
has a much shorter history. The basic principles of double entry 
bookkeeping have not changed a great deal since they were first 
introduced many years ago. Interpretive accounting, modes, 
system building, and forms of presentation have, however, ad- 
vanced considerably. Probably the greatest advancement has 
taken place in the past forty years. During this period there 
has appeared more accounting literature than ever before. This 
advancement has been due largely to the advancement in busi- 
ness itself. Years ago competition was not so worldwide and 
not nearly so keen as it is today. The advancements in science, 
communication, and transportation have seemed to bring the 
world closer together. Today many corporations organized as 
American, British, French, or German corporations are in truth 
international in scope. Business has seen its greatest develop- 
ment in the past forty years and so has accounting; they both 
go hand in hand. 

THE ACCOUNTING PROFESSION 

The accounting profession was first recognized in this coun- 
try in 1896, when New York State passed a law which regulated 
the practice of public accounting and granted to those already 



2 FUNDAMENTALS OF ACCOUNTING 

established in the practice of public accounting, and to those 
who might qualify subsequently in accordance with the statute, 
the designation of Certified Public Accountant. Since that date 
every state has passed a similar C.P.A. law. 

The C.P.A. laws govern only the practice of public account- 
ing. There is at present no legislation, state or national, re- 
stricting or governing the practice of accounting in private 
business. 

The requirements, set by the various State Boards of Public 
Accountants, which usually administer the C.P.A. laws, are dif- 
ferent in each state. In brief, however, the law requires certain 
preliminary general education which now varies from high 
school graduation to four years of college education, together 
with a certain period of practice with a recognized firm of Certi- 
fied Public Accountants. The practice requirement varies from 
two to five years, and must usually be completed before the can- 
didate may sit for the examination. The examinations, while 
quite thorough and perhaps difficult in many states, are not con- 
sidered so difficult by the person who has had the proper educa- 
tion and practice. Probably the principal reason for so many 
failures in the examinations is the inadequate preparation of 
many of the candidates examined. 

THE WORK OF A PUBLIC ACCOUNTANT 
SYSTEM BUILDING 

One of the most interesting pieces of work done by the prac- 
ticing Certified Public Accountant is that of designing an ac- 
counting system which will best serve the needs of a particular 
organization. Each type of business organization will differ, 
and often individual organizations of the same type may differ. 
An accounting system must therefore be " custom made " and 
should be designed so that it will yield the maximum of infor- 
mation with the minimum of effort. 



AUDITING 

After a system has been placed in operation, it must be con- 
stantly supervised to see that the purposes for which it was 
created are being carried out properly. Auditing, in brief, deals 



INTRODUCTION 3 

with the examination and verification of the accuracy of the 
accounting system, and the financial reports prepared therefrom. 



INVESTIGATIONS AND SPECIAL ASSIGNMENTS 

The Certified Public Accountant is often engaged by cor- 
porations, or designated by the courts, to carry out investiga- 
tions of various natures. He may prepare accounting for an 
estate, or records for a Receiver in Bankruptcy, or investigate 
a closed bank. 



TAX-CONSULTANT 

Another very important phase of the Certified Public Ac- 
countant's work is that which has to do with the federal and 
state income tax laws. Legislation of this kind requires proper 
accounting and reporting of income and expense in conformity 
with the law and regulations. The establishment of the Securi- 
ties Exchange Commission has also created a great deal of im- 
portant work for the Certified Public Accountant. 



COST ACCOUNTING 

Another most interesting field of accounting is that devoted 
to cost accounting. Many Certified Public Accountants do a 
great deal of work for manufacturers and often become special- 
ists in this line of work, just as others may specialize in " Wall 
Street/ 7 or " Insurance " accounting. There are, of course, 
some very fine cost accountants who are not Certified Public 
Accountants, but they are usually college graduates who have 
had a combined engineering and accounting training. 



MUNICIPAL ACCOUNTING 

This branch of accounting also utilizes the services of a 
specialist. In some states only certain licensed accountants may 
supervise or audit municipal records. In New Jersey, at the 
present time, only a " Registered Municipal Accountant," who 
holds an R.M.A. certificate from the State Board of Public 
Accountants, may practice in this field. 



4 FUNDAMENTALS OF ACCOUNTING 

STUDIES AND TRAINING FOR ACCOUNTING PROFESSION 
MUST BE BROAD 

By now the student has no doubt noticed that, while the field 
of accounting may be a very interesting one, it is at the same 
time a very broad field. Perhaps the ideal preparation for suc- 
cess in this profession would be a four-year liberal arts course, 
followed by a three-year graduate course in Accounting and 
Business. This preliminary study, in conformity with many 
state C.P.A. laws, must then be followed by three years' train- 
ing and practice with some recognized firm of Certified Public 
Accountants. The majority of students cannot afford all of this 
preliminary study and so many of our leading universities and 
colleges are now offering a four-year course which combines the 
essentials of the general courses and as many technical courses 
in accounting, law, finance, and economics as is possible. The 
State of New York now requires, and New Jersey after Jan. i, 
1944, will require, a college course of this description as the 
minimum preliminary educational qualification for candidates 
taking the C.P.A. Examinations. 

PROFESSIONAL SOCIETIES OF ACCOUNTANTS 

The present high position of the accounting profession owes a 
great deal to the work of many associations of professional ac- 
countants. In England and Scotland many professional so- 
cieties were formed long before any were organized in this 
country. Many of our first public accountants were Scottish 
or English " Chartered" accountants who came here as repre- 
sentatives of their firms or to practice as individuals. Our prin- 
cipal national association of certified public accountants is 
probably the American Institute of Accountants. The National 
Association of Cost Accountants, with local chapters in the 
principal cities of the United States, is another very important 
organization composed of accountants and executives inter- 
ested in cost accounting. Then there are the very splendid state 
associations of Certified Public Accountants which exist in most 
states and which have contributed a great deal to the advance- 
ment of the accounting profession. Another national organi- 
zation which must be mentioned is the present American Ac- 



INTRODUCTION 5 

counting Association, formerly the American Association of 
University Instructors of Accounting. This society has done 
a great deal to improve the status of the accounting profession. 

ACCOUNTANTS NOT CERTIFIED 

At this time, however, it might be well to state that all who 
study accounting need not have in mind entering the public ac- 
counting profession, for, as a matter of fact, the great majority 
of accountants are engaged by business organizations and are 
classed as private accountants. Many brilliant accountants are 
engaged in private practice as chief accountants, auditors, 
controllers, treasurers, and in other similar positions. Many 
of the men who occupy these positions have come up through the 
ranks; a few have been drawn from the staffs of public account- 
ants. All of these men have had one thing in common, a 
thorough training in accounting and business. The beginning 
student, therefore, should appreciate the value of a good basic 
course in accounting. 

VALUE OF ACCOUNTING STUDY TO THOSE NOT PRIMARILY 
INTERESTED IN ACCOUNTING 

There are many students who do not contemplate entering 
business; some will study law, some banking, some medicine, 
while others may study engineering or architecture. Will these 
students benefit by a study of accounting? Perhaps the best 
answer will be found if we discuss the relationship which exists 
between accounting and several of the professions. 

LAW AND ACCOUNTING 

Practicing attorneys have long recognized the need of some 
knowledge of accounting, particularly in certain phases of their 
work. This is particularly true in such fields as corporation law, 
income tax law, the law of partnerships, trusts, estates, and 
fiduciary law. All these fields demand a considerable knowl- 
edge of accounting and many attorneys recognizing this need 
have taken courses in accounting after being admitted to prac- 
tice. Many law schools today specify Accounting Principles 
as a required pre-law course. 



6 FUNDAMENTALS OF ACCOUNTING 

ENGINEERING AND ACCOUNTING 

Many engineering schools not only include an elementary 
accounting course but offer in their course of study Cost Ac- 
counting as well. One well known engineering educator has 
remarked that a good cost accountant must be a good engineer 
as well as an accountant. 

BANKING AND ACCOUNTING 

The field of banking is so closely connected with business 
that a thorough knowledge of business is recognized as an es- 
sential part of the education of a banker. The business train- 
ing, of course, must be broad and include much study in the 
field of economics and business. An essential part of this train- 
ing should be a thorough knowledge of accounting. This part 
is recognized by the bankers, and the American Institute of 
Banking has included several courses in accounting in its 
course of study recommended for bank employees who wish to 
broaden their education. Students who contemplate entering 
this very interesting field will do well to include the Principles 
of Accounting in their course of study. 

MEDICINE, DENTISTRY, ARCHITECTURE AND ACCOUNTING 

Included here are several professions which some students 
may be preparing for and which group probably has less use for 
accounting than any other group, in their own professional 
sphere. However, how often will the successful doctor, dentist, 
or architect come into contact with business problems? If at 
all, then a knowledge of accounting might come in handy. An- 
other thought to this last group: from experience we know that 
many who originally set their goals on some of the professions 
wind up in business, and all too frequently unprepared; or in 
their final year of college they scurry about to get into their 
programs all the business courses they can. 

THE PLAN OF THE TEXT YOU ARE ABOUT TO STUDY 

Now that some of the questions asked by the beginning stu- 
dent have been answered, it might be well to see how this par- 
ticular text presents the principles of accounting. 



INTRODUCTION 7 

In the first part of the introduction it was stated that, while 
the fundamentals of accounting had changed little in recent 
years, certain improvements in use and interpretation had taken 
place. One of the chief advances of modern times has been in 
the method of presenting accounting to beginning students. In 
the early days boys were apprenticed to counting houses and 
learned by doing, a very long, slow course. The first schools, 
private business schools, taught by this method. Students were 
given a high stool at a high bookkeeping desk, red and black 
ink, actual journals and ledgers, and the instructors (for the 
most part graduate bookkeepers) dictated long bookkeeping 
examples and the student learned by doing. 

About nineteen hundred, when colleges first started teaching 
accounting, a more scientific method of teaching was employed. 
We shall not take any time, however, to trace the several steps 
in advancement made by the colleges in their study of methods 
of teaching accounting. The text starts with a study of Finan- 
cial Statements, the finished product of accounting state- 
ments which are prepared only after all the bookkeeping work 
of the period has been completed and the ledger closed and bal- 
anced. The beginning student might therefore wonder why 
the text starts here rather than with the origin of the business 
transaction. The purpose is simple; it is the writer's wish that 
the students first view the completed product, after which the 
finished whole will be taken down part by part. After the several 
parts have been studied and the student has a good idea where 
each part fits, then he will be ready to build, and the student 
may be assured that he will build well and efficiently because he 
will know in advance what he is building. He will have his goal 
before him in the form of the completed financial statements. 



CHAPTER II 
THE BALANCE SHEET 

PURPOSE OF FINANCIAL STATEMENTS 

The successful operation of a business requires a study of 
financial statements. The Balance Sheet, which sets forth the 
financial condition, and the Statement of Profit and Loss, which 
reviews the operations of the business over a period of time, are 
financial statements which are as essential to the operation and 
control of a business, as the barometer, compass, and charts are 
to the successful navigation of a ship. These statements, when 
properly prepared, may be of the utmost importance to the man- 
agement in controlling the affairs of a business. 

The grantors of credit in general, as well as banks and busi- 
ness organizations furnishing goods on credit, are also inter- 
ested in financial statements. A company which can present a 
set of good financial statements will ordinarily have no trouble 
in obtaining either a loan or credit. 



BALANCE SHEET ILLUSTRATED 

The following is a very simple balance sheet prepared from 
the books of Mr. John H. Thomas: 

JOHN H. THOMAS 
Balance Sheet as of December 31, 19 



Assets 




Liabilities 




Cash 


$ 2,000.00 


Notes Payable 


$ 1,000.00 


Merchandise 




Accounts Payable 


12,000.00 


Inventory 


11,500.00 


Mortgage Payable 


IO,OOO.OO 


Accounts Receivable 


14,000.00 


Total Liabiliti-es 


$23,OOO.OO 


Land 


2,000.00 






Buildings 


18,000.00 






Office Equipment 


1,500.00 


Net Worth 




Delivery Equipment 


1,000.00 


John H. Thomas 


27,000.00 


Total Assets 


$50,000.00 


Total Liab. & N. W. 


$50,000.00 



Illustration No. i 



THE BALANCE SHEET 9 

BALANCE SHEET AS OF A PARTICULAR DATE 

Note in the example that the balance sheet shows Mr. 
Thomas 7 financial condition as of December 31, 19 . This 
is of considerable importance, for his financial condition might 
have been, and probably was, different a day before this date 
and without a doubt will be different each day as time passes. 
A going business cannot stand still, it must either go forward, 
as all successful businesses do, or it will go down; it cannot stay 
in any one position. 

THE ACCOUNTING PERIOD 

Years ago, when business moved at a much slower pace, and 
when competition was not so keen, financial statements pre- 
pared annually were considered sufficient for all ordinary re- 
quirements. Today, however, the business man cannot wait so 
long to be apprised of the condition of his affairs, and as a result 
the monthly accounting period is quite widely used at present. 
Many companies continue to have annual reports made for 
stockholders and others, but for management purposes demand 
statements much more frequently. 

BALANCE SHEET DEFINED 

Briefly, a balance sheet is one of the important financial state- 
ments, prepared from a set of books kept on the double entry 
principle, which exhibits the financial position of an individual 
or business enterprise at a particular moment of time by means 
of three elements: assets, liabilities, and net worth. 

THE THREE ELEMENTS OF THE BALANCE SHEET 

In the definition of a balance sheet it was stated that the 
financial condition of an individual or a business enterprise was 
shown by means of three elements. These three elements are 
classes or types of accounts; namely, assets, liabilities, and net 
worth. One of the primary purposes of this chapter is to give 
the student a thorough understanding of these three groups of 
accounts, together with a knowledge of the relationship which 
exists between them. 



io FUNDAMENTALS OF ACCOUNTING 



ASSETS DEFINED 

An asset may be briefly defined as anything of value owned 
by the business. On the balance sheet above, several typical 
assets have been illustrated. Assets consist of property, real 
and personal. All property owned by the business is listed on 
the left hand side under the caption assets. In this particular 
balance sheet Mr. Thomas owns assets with a total valuation 
of $50,000.00. 

LIABILITIES DEFINED 

A liability is anything owed by the business to creditors other 
than the proprietor. Several typical liabilities have been given 
in the balance sheet above and will be sufficient for our illustra- 
tion at this time. Liabilities may be further defined as the 
claims of " outsiders " against the assets of the business, or 
more briefly the creditors' equity in the property of a business. 

CAPITAL OR NET WORTH DEFINED 

The difference between the first two elements measures the 
proprietor's net worth, and is technically known as capital, al- 
though the former term is much more descriptive and therefore 
preferable to the older term, capital. Another term sometimes 
used to measure this difference is proprietorship. 

In a sole proprietary business the net worth is simply labeled 
with the proprietor's name, as in Illustration No. i. 



THE BALANCE SHEET 



ii 



NET WORTH IN A PARTNERSHIP 

In a partnership the net worth section will be represented by 
the capital accounts of two or more partners. 

BROWN AND GREEN PARTNERSHIP 
Balance Sheet as of October i, 19 



Assets 
Cash 
Accounts Receivable 
Notes Receivable 
Land 
Buildings 
Sundry Accounts 

Total Assets 


$ 6,000.00 
12,000.00 
3,000.00 

10,000.00 

30,000.00 
4,000.00 


Liabilities 
Accounts Payable 
Notes Payable 
Mortgage Payable 

Total Liabilities 

Net Worth 
John Brown Capital 
Thomas Green Capital 
Total Liab. & N. W. 


$ 8,000.00 
2,000.00 
15,000.00 


$25,000.00 

$18,000.00 
22,000.00 


$65,000.00 


$65,000.00 



Illustration No. 2 

In this illustration the partnership has a net worth of 
$40,000.00. This is divided, however, between the partners 
as indicated above. 



NET WORTH IN A CORPORATION 

On a corporation balance sheet the net worth will be made 
up usually of the capital stock accounts plus a surplus or minus 
a deficit. 

EXCELSIOR MANUFACTURING Co., INC. 
Balance Sheet as of December 31, 19 



Assets 

Cash 
Notes Receivable 
Accounts Receivable 
Inventories 
Land, Buildings, & 
Sundry Assets 

Total Assets 


$ 25,000.00 
10,000.00 
60,000.00 
100,000.00 

135,000.00 


Liabilities 

Accounts Payable 
Notes Payable 
Sundry Liabilities 
Total Liabilities 

Net Worth 
Capital Stock 
Surplus 
Total Liab. & N. W. 


$ 40,000.00 
20,000.00 
50,000.00 


$110,000.00 

$200,000.00 
20,000.00 


$33 >^_^ 


$330,000.00 



Illustration No. 3 



12 FUNDAMENTALS OF ACCOUNTING 

In this illustration the corporation has a net worth of $220,- 
ooo.oo. This, however, belongs to the stockholders rather 
than to any one individual. The $200,000.00 represents 2000 
shares of stock, assuming a $100.00 par value. The excess of 
net worth over the stock outstanding represents a surplus. If 
the net worth of the corporation were less than the $200,000.00 
worth of capital stock, then there would be a deficit and this 
would appear as a deduction from the capital stock account in 
order to balance the total assets on the opposite side. 

THE FUNDAMENTAL EQUATION OF THE BALANCE SHEET 

From the foregoing illustrations it will be noted that in every 
instance the total assets were always equal to the total liabili- 
ties plus net worth. This truth may be set forth in the form 
of an equation : 

Assets = Liabilities + Net Worth 

Or perhaps in a more usable form, we may say: 
Assets Liabilities = Net Worth 

This is frequently spoken of as the fundamental equation of 
the balance sheet. It may be reduced to its simplest form: 

A L = NW 

ASSETS EQUAL OWNERSHIP: LIABILITY AND NET WORTH 

DISTINGUISHED 

The property belonging to a business the assets are 
listed on the left hand side of the balance sheet, while the own- 
ers' equities the liability and net worth accounts are listed 
on the right hand side of the balance sheet. In a sole proprie- 
tary business the owner has physical control as well as owner- 
ship of the property. His claim to the assets, however, is sec- 
ondary to the claim of the creditors. In case of financial 
difficulty, such as insolvency or bankruptcy, the creditors would 
have to be paid one hundred cents on the dollar before the pro- 
prietor could claim one cent. Further, if in liquidation of the 
assets there were not enough cash to pay the liabilities (credi- 
tors) in full, then the proprietor would have to turn over as 



THE BALANCE SHEET 13 

much personal property as required by the receiver in order to 
be discharged in bankruptcy. 

This unlimited liability of the proprietor, or partners in a 
partnership, for the debts of their business is one of the serious 
drawbacks of these forms of business organization. In a cor- 
poration, on the other hand, while the stockholders' (owners of 
the net worth) claims are also secondary to the claims of the 
creditors, there is one important difference. In case of finan- 
cial difficulty in a corporation the stockholders have no liability 
further than their stock contributions. Should a corporation 
go bankrupt, the creditors must be paid in full before the stock- 
holders get anything and if in liquidation there is not enough to 
pay the liabilities in full, the receiver would pro-rate what he 
had to the creditors. The stockholders, of course, would get 
nothing, but they would not be called upon for any further con- 
tribution. Their liability is limited to the amount of their capi- 
tal stock. This is simply a legal difference between the two 
forms of business organization. 

BUSINESS TRANSACTIONS AND THE BALANCE SHEET 

At this point a series of transactions involving the elements 
of the balance sheet are presented, together with balance sheets 
illustrating the situations set forth in the transactions. 

Transaction No. i. Mr. X has $10,000.00 cash with which 
he intends to start business. (At this time a balance sheet 
would hardly be required, nor would balance sheets be re- 
quired for each succeeding transaction. They are shown here 
simply to illustrate some of the truths regarding the operation 
of the fundamental equation.) 

MR. X 

BALANCE SHEET 



Assets 




Liabilities 




Cash 


$10,000.00 




none 






Net Worth 








Mr. X 


$10,000.00 


Total Assets 


$10,000.00 


Total Liab. 6- N. W. 


$10,000.00 



The result of this transaction is an increase in the asset cash 
offset by an equal increase in net worth. 



14 FUNDAMENTALS OF ACCOUNTING 

Transaction No. 2. Continuing the narrative, suppose Mr. X 
spends $3000.00 of this cash for furniture and equipment. A 
balance sheet at this point would be: 





A ssets 






Liabilities 




Cash 
Furniture & Equipment 

Total Assets 


$ 7,000.00 
3,000.00 


Mr. X 

Total Liab. 


Net Worth 

6- N. W. 


none 

$10,000.00 


$10,000.00 


$10,000.00 



It will be noted from a study of this balance sheet that there 
has been merely an exchange of assets of equal value with no 
resulting changes in net worth. 

Transaction No. 3. Let us now assume that Mr. X has re- 
ceived $2000.00 worth of merchandise which he purchased on 
credit from the New York Wholesale Company, with which to 
stock his shelves. The transaction would result in the following 
balance sheet: 



Assets 
Cash 
Furniture & Equipment 
Merchandise 

Total Assets 


$ 7,000.00 
3,000.00 
2,000.00 


Liabilities 
New York Wholesale Co. 

Net Worth 

Mr. X 
Total Liab. & N. W. 


$ 2,000.00 
IO,OOO.OO 


$12,000.00 


$I2,OOO.OO 



The student will observe that, although the total assets have 
increased from $10,000.00 to $12,000.00, at the same time there 
has been established a liability equal in amount, which has pre- 
vented the net worth from moving either upward or downward. 
Mr. X's proprietorship or business position thus far has not 
changed, notwithstanding the fact that his assets have changed 
in form and have grown in amount. This is easily understood 
if in each case the student will apply the fundamental equation 

Assets = Liabilities + Net Worth. 

Transaction No. 4. To carry on Mr. X's business a little 
further, suppose he sells for $500.00 cash some of the mer- 
chandise which cost him $300.00. The effect of this transaction 
is illustrated in the following balance sheet: 



THE BALANCE SHEET 



Assets 

Cash (7,000 + 500) $ 7,500.00 

Furniture & Equipment 3,000.00 

Merchandise (2,000 300) 1,700.00 



Total Assets 



$12,200.00 



Liabilities 
New York Wholesale Co. $ 2,000.00 

Net Worth 
Mr. X 

(10,000 + 200 profit) 10,200.00 

Total Liab. & N. W. $12,200.00 



From the balance sheet above the student should note that 
profits resulting in increased assets belong to the proprietor. 
Such increases must, therefore, be added to his capital. This is 
true because the fundamental equation must always hold 
A L = NW. In the balance sheet above the assets have 
grown from $12,000.00 to $12,200.00, but the liabilities have 
remained the same. Consequently, net worth, the only other 
factor, had to be increased. 

Transaction No. 5. Now suppose that Mr. X, wishing to 
expand his business, borrows $3000.00 from the bank on his 
personal, note. This transaction will change the balance as 
shown below. 



Assets 
Cash 
Furniture &"Equipment 
Merchandise 

Total Assets 


$10,500.00 
3,000.00 
1,700.00 


Liabilities 
New York Wholesale Co. 
Notes Payable 
Total Liabilities 

Net Worth 
Mr. X 
Total Liab. & N. W. 


$ 2,000.00 

3,000.00 


$ 5,000.00 
10,200.00 


$15,200.00 


$15,200.00 



This transaction increased total assets by $3000.00 cash and 
at the same time increased liabilities in the form of notes pay- 
able by the same amount. Therefore, net worth remained un- 
changed. 

Transaction No. 6. Let us suppose that the New York 
Wholesale Company accepts a sixty-day note in payment of its 
account. This will change the balance sheet as follows: 



Assets 

Cash 

Furniture & Equipment 

Merchandise 

Total Assets 





Liabilities 




$10,500.00 
3,000.00 
1,700.00 


Notes Payable 

Net Worth 
Mr. X 

Total Liab. fir N. W. 


$ 5,000.00 
10,200.00 


$15,200.00 


$15,200.00 



i6 



FUNDAMENTALS OF ACCOUNTING 



This transaction illustrates the decrease of one liability by 
the increase of another liability. 

From a study of the foregoing transactions illustrating 
changes in the elements of a balance sheet, the following truths 
may be deduced : 

An increase in an asset may be offset by: 

1. An Increase in Net Worth (See Transactions No. i and No. 4) 

2. An Increase in a Liability (See Transaction No. 5) 

3. A Decrease in another Asset (See Transaction No. 2) 

An increase in a liability may be offset by: 

1. An Increase in an Asset (See Transactions No. 3 and 5) 

2. A Decrease in another Liability (See Transaction No. 6) 

An increase in net worth may be offset by: 

i. An Increase in an Asset (See Transactions No. i and 4) 

Other transactions involving the elements of the balance sheet 
might be mentioned, but in every instance the resulting equation 
will be, total assets equal to total liabilities plus net worth. 

At this point let us assume that Mr. X has been in business 
for a year and the following balance sheet presents his financial 
position : 

MR. X 

Balance Sheet, as of June 30, 19 



Assets 




Liabilities & Net Worth 


Cash 


$ 1,876.50 


Liabilities: 


Merchandise Stock 


3,450.00 


Mortgage Payable $15,000.00 


Accounts Receivable 


16,380.50 


Notes Payable 4,500.00 


Land & Buildings 


20,000.00 


Accounts Payable 13,896.60 


Office Equipment 


1,400.00 




Delivery Truck 


3,000.00 


Net Worth: 


Notes Receivable 


2,800.00 


Mr. X Capital a/c 15,510.40 


Total Assets 


$48,907.00 


Total Liab. fir N. W. $48,907.00 



Illustration No. 4 

In summarizing let us note: 

(1) That the balance sheet presents Mr. X's financial position at 
a given moment of time as of June 30, 19 . 

( 2 ) All of the items on the asset side represent things of value in 
Mr. X's possession. 

(3) The items on the right-hand side represent ownership claims 
against the assets of the business as a whole. 



THE BALANCE SHEET 17 

If these claims are held by outsiders, they constitute the lia- 
bilities of the business, while the owner's equity or net worth 
is measured by the difference between assets and liabilities. 

It will be noted in the illustration above that there is listed 
among the assets an item Land and Buildings, valued at 
$20,000.00. This asset is in the possession of, and is being used 
by, the business, and the title is probably in Mr. X's name. But 
note the fact that on the liability side there is the account Mort- 
gage Payable in amount of $15,000.00. This means that al- 
though Mr. X owns the land and buildings, and has control 
over them, he has mortgaged them to three-fourths of their 
book-value and has by that act created an obligation of 
$15,000.00 in favor of the mortgagee (the person who loaned 
him the money) . 

(4) The third characteristic is a corollary of the second, and 
is that the totals of the balance sheet are always equal. This 
follows logically from the very nature of the fundamental ac- 
counting .equation, and is, as we shall see later on, the corner- 
stone of double entry bookkeeping and accounting. 

The balance sheet above, although a very elementary form, 
has given us the fundamental elements; and, regardless of 
the size of the business or its particular form of organization, 
whether sole proprietary, partnership, or corporate, these fun- 
damental truths would not change. 



REPORT FORM OF BALANCE SHEET 

The form of balance sheet so far illustrated is generally 
known as the balance or account form, because it is drawn 
somewhat in the form of a scale or balance which is also simi- 
lar in form to an account. There is no real reason except cus- 
tom that the assets should appear on the left side and the 
liabilities and net worth on the right side. As a matter of 
fact, in England the balance sheet is prepared in exact reverse 
order. 

Another form of balance sheet, often used when space for dis- 
play is limited, is known as the report form of balance sheet. 

This form displays first the assets, then the liabilities, fol- 
lowed by the net worth section. 



1 8 FUNDAMENTALS OF ACCOUNTING 



REPORT FORM OF BALANCE SHEET ILLUSTRATED 

The following balance sheet in report form contains the same 
information as the balance sheet of Mr. Thomas (Illustration 
No. i), shown on page 8 in balance form. 



JOHN H. THOMAS 
Balance Sheet, as of December 31, 19 

ASSETS 

Cash $ 2,000.00 

Merchandise Inventory 11,500.00 

Accounts Receivable 14,000.00 

Land 2,000.00 

Buildings 18,000.00 

Office Equipment 1,500.00 

Delivery Equipment 1,000.00 

Total Assets $50,000.00 

LIABILITIES 

Notes Payable $ 1,000.00 

Accounts Payable 12,000.00 

Mortgage Payable 10,000.00 

Total Liabilities $23,000.00 

NET WORTH 

John H. Thomas $27,000.00 

Total Liabilities & Net Worth $50,000.00 

This form is quite frequently used in newspaper display and 
in typing where a wide carriage machine is not available. For 
our work in the text and the classroom, the balance form is to 
be preferred because it portrays much better the fundamental 
idea of equilibrium which is always present in a balance sheet. 

CLASSIFIED BALANCE SHEETS 

The beginning student will do well to master the simple bal- 
ance sheets so far presented, however, because statements taken 
from actual business are often encountered by the beginning 
student; and since these practical statements are frequently in 



THE BALANCE SHEET 19 

classified form, the balance sheet on page 20 is presented and 
very briefly explained. A more detailed study of the proper 
:lassification of accounts must of course be deferred until the 
student has a stronger foundation upon which to build. 

In further explanation of this balance sheet it might be well 
it this time to study the several subdivisions, one group at a 
:ime. 

CURRENT ASSETS 

Included in this group are cash and any other asset which in 
the usual course of business will be converted into cash in a 
short period of time. Other terms that are sometimes used to 
describe assets in this group are quick assets and liquid assets. 

FIXED ASSETS 

The second classification, Fixed Assets, often called Capital 
4ssets, includes property of a more permanent nature owned by 
the business. Assets in this grouping are not held for realiza- 
tion into cash, as are current assets. Office furniture and equip- 
ment on the books of a commercial organization would be part 
3f its permanent equipment and a fixed asset. If the company 
were in the office furniture and supply business, then such an 
account would be an Inventory account, held with the purpose 
3f sale and conversion into cash, and therefore a current asset. 
The purpose for which an asset is held, therefore, has a bear- 
ing on how the particular asset shall be classed. 

DEFERRED CHARGES 

Another subdivision of the balance sheet is one headed De- 
ferred Charges or Prepaid Expense Items. Included here are 
expense items which have been purchased during the current 
period, but which have an unconsumed value that will be used 
in a subsequent period. 

OTHER ASSETS 

This caption is frequently used to list a few assets not readily 
classed in the other groups. Intangible assets, such as those 
listed in our illustration, will often make up the bulk of this 



VAN SICKLE OIL Co., INC., Balance Sheet, as of Dec. 31, 19 

Assets 
Current Assets: 

Cash in Banks $ 13,280.00 

Petty Cash Fund 250.00 

Accounts Receivable $65,820.00 

Notes Receivable 9,000.00 

$74,820.00 
Less Reserve for Doubtful Accounts 8,269.20 

66,550.80 

Inventory 30,200.00 

Total Current Assets $110,280.80 

Fixed Assets: 

Land $ 8,000.00 

Buildings $40,000.00 

Less Reserve for Depreciation .... 4,400.00 

35,600.00 

Machinery and Equipment $28,200.00 

Less Reserve for Depreciation 2,470.00 

25,730-00 

Delivery Equipment $30,000.00 

Less Reserve for Depreciation 15,000.00 

15,000.00 

Total Fixed Assets 84,330.00 

Deferred Charges : 

Advertising Prepaid $ 1,200.00 

Insurance Prepaid 800.00 

Fuel Inventory 1,600.00 

Total Deferred Charges 3 ,600.00 

Other Assets: 

Patent Rights $ 5,000.00 

Good-will 20,000.00 

25,000.00 
Total Assets $223,210.80 

Liabilities 
Current Liabilities: 

Wages Accrued $ 600.00 

Taxes Payable 240.00 

Acceptances Payable 2,400.00 

Notes Payable (Bank) 6,000.00 

Accounts Payable _ 42 ,500.76 

Total Current Liabilities $ 51,740.76 

Fixed Liabilities: 

Mortgage Payable $ 18,000.00 

Chattel Mortgage (Auto Truck) 1,200.00 

Notes Payable (Building and Loan) 6,420.00 

Total Fixed Liabilities 25,620.00 

Total Liabilities $ 77,360.76 

Net Worth 

Capital Stock Authorized (Par $100.00) $500,000.00 

Less Unissued Stock 390,000.00 

Issued and Outstanding 1 10,000.00 

Surplus 35,850.04 

$223j2I0.8o 



THE BALANCE SHEET 21 



RESERVES 

Briefly, Reserves are valuation accounts, and are placed on 
the books so that the assets may be exhibited at their true value. 
A more complete treatment of reserves and similar accounts 
must be deferred to a subsequent chapter. 



CURRENT LIABILITIES 

Here are listed those accounts which must be paid in a rela- 
tively short period of time. The length of the period which is 
used to separate current from fixed liabilities must depend upon 
individual businesses. It may be ninety days, six months, or a 
year. An important rule to remember, however, is to use the 
same period to mark off current liabilities as is used on the other 
side to classify current assets. This is important because a 
comparison of these two groups, current assets and current lia- 
bilities, will indicate the working capital of a business. There- 
fore, unless the same period is used on both sides, any result 
would be unreliable. Applying this rule, short-term notes pay- 
able are current liabilities, while long-term notes payable must 
be classed as fixed liabilities. In our illustration above notes 
payable (building and loan) are classed as fixed liabilities, be- 
cause no doubt they represent long-term notes. All installments 
becoming due currently, of course, should be listed with current 
liabilities. 

FIXED LIABILITIES 

Here are grouped those liabilities which mature in a period 
beyond that reserved to limit current liabilities. 

NET WORTH 

The illustration above is that of a corporation and the net 
worth is made up of three accounts. Authorized Capital Stock 
in amount of $500,000 simply means the company's charter 
permitted it to issue stock to that amount. The second account, 
Unissued Stock, represents the amount of stock still unissued 
and which must be deducted from the authorized capital stock 
in order to determine the amount of stock which is issued and 
outstanding. The Surplus account measures the excess of as- 



22 FUNDAMENTALS OF ACCOUNTING 

sets over and above capital stock outstanding plus total liabili- 
ties. Should the assets be less than such a total, then instead of 
a Surplus, there would be a Deficit. 



QUESTIONS ON THE CHAPTER 

1. Give two reasons for preparing a balance sheet. 

2. Is it important to date a balance sheet? Why? 

3. Define balance sheet. 

4. Define assets, liability, net worth. 

5. What other terms are frequently used in place of net worth? 

6. What is the fundamental equation? 

7. Why are the claims of outsiders listed apart from those of the 
proprietor? 

8. If assets are increased, what other changes may take place on 
the balance sheet? 

9. What factors may cause the proprietor's net worth to increase 
or decrease? 

10. Give an example of 

(a) Increase in liability and increase in assets; 

(b) Increase in assets with increase in net worth. 

1 1. If liabilities are increased, what other changes are likely on the 
balance sheet? 

12. If the proprietor of a business borrows money from his bank 
on his personal note, but for the use of the business, is the proprietor's 
net worth increased or not? Give reasons. 

13. Distinguish clearly between proprietor's and creditors' equities 
in the assets of a business. 

14. Explain and illustrate the difference between the net worth 
section of a balance sheet for a sole proprietor, for a partnership, and 
for a corporation. 

15. (a) What do you understand by limited liability of stockhold- 
ers? (b) Unlimited liability of a sole proprietor for debts of his busi- 
ness? (c) What is the liability of partners for debts in a partnership 
business? 

1 6. What may be meant by the phrase " I own a million dollar 
business "? 

17. How are assets and liabilities usually classified? Why? 

1 8. Explain under what circumstances an expense item might be 
properly classified as an asset. 

19. What do you understand as working capital? 

20. Explain the net worth section 

( a ) for a sole proprietor 

( b ) for a partnership 

( c ) for a corporation 



THE BALANCE SHEET 23 



PROBLEM MATERIAL 

PROBLEM i 

Mr. Daniel Morgan rented a vacant store at 90 Main Street in 
which he planned to conduct an Automobile Tire, Oil and Gasoline 
sales and service business. At September i, 1939 he was ready to 
start business and asks you to prepare his opening balance sheet. He 
advises you that he has the following: Gasoline Pumps and other 
equipment which cost him new $900.00; he owes the Owens Pump 
Co. $500.00; he has purchased tires and tubes and other miscellane- 
ous supplies in total $2400.00; he owes the Star Tire Co. $840.00; his 
shelving and other store equipment cost him $600.00; he owes the 
Store Equipment Co. $300.00; he also owes the Standard Gas Co. 
for 8000 gallons of gasoline at $.12 per gallon and $300.00 for oil 
which has been delivered to him but not paid for. He has a cash bal- 
ance of $2240.00. 

Required: A balance sheet for Mr. Morgan. 

PROBLEM 2 

Mr. Daniel Morgan has completed one year in business and re- 
quests you to prepare his balance sheet as of September i, 1940. 
From a study of his records you determine that two new gasoline 
pumps have been installed and other equipment purchased so that 
there are now pumps and equipment valued at $2000.00. The pres- 
ent stock of Tires and Tubes is $2800.00; the store equipment is now 
valued at $900.00. Mr. Morgan owes to sundry creditors accounts 
totalling $2940.00. His inventory of Gasoline is 12,000 gallons at 
$.12 per gallon and Oil costing him $420.00 is also on hand. Mr. 
Morgan during the year negotiated a loan from the bank which has 
a present balance due of $1800.00. He purchased a delivery and 
service truck for $900.00 on which there is unpaid $500.00 in finance 
notes. The cash on hand and in the bank is $1440.00. 

Required: A balance sheet for Mr. Morgan. 

PROBLEM 3 

Mr. D. Fraser, a partner of the firm of Fraser and Thompson, has. 
engaged you to prepare a balance sheet for the partnership as of Oc- 
tober i, 1940. An examination of the company's books reveals the 
following accounts: 

Mr. D. Fraser Capital Account $9450.00; Mr. A. Thompson Capi- 
tal Account $8545.00; Cash on hand and in the bank $3417.40; 
Notes Receivable $1600.00; Notes Payable $2400.00; Accounts Re- 
ceivable $6218.20; Accounts Payable $5840.60; Inventory $3600.00;, 



24 FUNDAMENTALS OF ACCOUNTING 

Land and Buildings $15,000.00; Mortgage Payable $10,000.00; Ma- 
chinery and Equipment $6000.00; Office Equipment $400.00. 

Required: A balance sheet for the firm of Fraser and Thompson, as of 
October i, 1940. 

PROBLEM 4 

Mr. J. B. Franklyn, president of the Franklyn Sales Inc., asks you 
to prepare the corporation's annual balance sheet. An examination 
of the general ledger indicates that the books have been closed and 
the accounts balanced. You abstract the following accounts and their 
balances at December 31, 19 . 

Accounts Receivable $14,728.00; Reserve for Doubtful Accounts 
$294.56; Store Equipment $12,480.00; Reserve for Depreciation of 
Store Equipment $1872.00; Notes Receivable $4800.00; Accounts 
Payable $42,318.00; Cash $6280.74; Notes Payable $6000.00; In- 
ventory of Merchandise $36,821.32; Delivery Equipment $6000.00; 
Fuel Inventory $320.00; Prepaid Insurance $240.00; Common Capi- 
tal Stock $25,000.00; Surplus $6345.50; Office Equipment $1600.00; 
Reserve for Depreciation of Office Equipment $240.00. Reserve for 
Depreciation of Delivery Equipment $1200.00. 

Required: A balance sheet in report form, similar to the illustration 
on page 20 of your text. 

PROBLEM 5 

Mr. F. Brown who conducts a hardware business requests you to 
prepare a classified balance sheet in report form as of December 31, 
1940, using proper account titles from the description material listed 
below. There was $3642.18 Cash in the bank, and a Petty Cash fund 
of $100.00 on hand. There were notes receivable from customers 
in total of $2200.00 and accounts with customers in amount of 
$6824.12. However, against these notes and accounts there was a 
reserve for doubtful accounts in amount of $180.48. There were 
short-term notes given to trade creditors in total $3000.00, and ac- 
counts payable of $16,200.42. The Company owned land valued at 
$2000.00, upon which it had constructed a building which cost $16,- 
ooo.oo, and against which a reserve for depreciation of $3200.00 had 
been accumulated. Machinery and other permanent equipment had 
been installed at a cost of $7200.00, against which a reserve of 
$1440.00 had been accumulated. There was, however, a Mortgage 
on the Land and Buildings in amount of $8000.00 and Chattel Notes 
Payable in two years of $2400.00 against the machinery. The Com- 
pany also owned Office Equipment which cost $900.00 and against 
which it had a reserve of $180.00. There was on hand listed at cost 
price merchandise stock worth $14,754.00 (the current market price 
was considerably higher). The Company also had an advertising 
contract on which there was a prepaid value of $1200.00, and simi- 



THE BALANCE SHEET 25 

larly there were prepaid Insurance premiums valued at $240.00. Mr. 
Brown's capital account had a credit balance of $20,459.40. 

Required: A classified balance sheet in report form similar to the illus- 
tration on page 20 of your text. 

PROBLEM 6 

Mr. K. Brewer applies for a loan at the bank on Jan. 15, 1940. 
The banker asks him for a copy of his last balance sheet, prepared 
when the books were closed Dec. 31, 1939. In checking the books 
and records Mr. Brewer finds he had lost his only copy of the bal- 
ance sheet and asks you to prepare a new one for him as of the end 
of 1939. You discover that the merchandise Inventory Account sheet 
is missing from the ledger binder. However, you gather the remain- 
ing information as to account balances at the end of 1939 as fol- 
lows: Cash $1042.20, Accounts Payable $1826.30, Notes Receivable 
$500.00, Mortgage Payable $4000.00, Accounts Receivable $1224.00, 
Notes Payable $300.00, Land and Buildings $8000.00, Mr. K. Brewer 
Capital $6710.50. 

Required: From the facts above determine the amount of the mer- 
chandise inventory and prepare a balance sheet as of December 31, 
IQ39- 



CHAPTER III 
THE PROFIT AND LOSS STATEMENT 

PURPOSE 

Another important statement prepared by the accountant is 
the Profit and Loss Statement. This statement reviews the op- 
erations of the business over a limited period of time and sets 
down in a systematic arrangement the several items of income 
and expense leading to the net change in capital or proprietor- 
ship a profit or a loss for the period under review. 

Men engage in business with the hope and intention of mak- 
ing a profit. Although not all of them succeed, as even a per- 
functory study of bankruptcies will show, enough of them do 
enjoy gains to encourage others to take chances. Men will 
make a profit and succeed, in a business way, if they can man- 
age to sell their goods or render their services for an income 
which is greater than the total cost of procuring and selling such 
goods or services. On the other hand, should their costs or ex- 
penses exceed their total income, obviously the net result will 
be a loss rather than a profit; and, unless this loss is temporary 
and can be borne until the tide changes, the operators of such 
businesses must fail. 

A study of these two fundamental factors, income and ex- 
penses, should therefore be given considerable attention not 
only by the student, but also by the business man. The busi- 
ness man who can control these two factors in such a manner 
that income will always exceed expense will be assured of suc- 
cess. In fact, all that a merchant has to do is to " take in " from 
sales and other sources of income more than he has to " lay 
out " for the various expenses of doing business. A very sim- 
ple formula it would seem, and fundamentally there is no doubt 
of its truth. The real difficulty, of course, is to put the formula 
to work. 

The banker in passing on a loan will rely to a large extent 
upon the balance sheet, because that statement exhibits the ap- 
plicant's present financial position. This information, while 
vitally important, must be further supplemented by another 

26 



THE PROFIT AND LOSS STATEMENT 27 

statement which will show the banker, or other interested per- 
son, how the company arrived at its present position. The 
banker may compare several balance sheets and thus learn the 
trend of a business and its probable outlook for the future, but 
a much better study can be made from several profit and loss 
statements. 



PROFIT AND LOSS STATEMENT AND BALANCE SHEET 
DIFFERENTIATED 

The Balance Sheet exhibits the financial position of a com- 
pany on a definite date, whereas the profit and loss statement 
reviews the activities of a business over a period of time, and 
shows the changes which have taken place between two dates. 
This difference is recognized in the headings of the two state- 
ments. 

The heading of the balance sheet shows the definite date 
on which the balance sheet was prepared, as: 

JOHN H. THOMAS 
Balance Sheet, as of December 31, 1940 

The heading of the profit and loss statement, on the other 
hand, will state the period covered by the statement, as: 

JOHN H. THOMAS 

Profit and Loss Statement 
for the six months 7 period ended December 31, 1940 

or 

JOHN H. THOMAS 

Statement of Income, Profit and Loss 
for the period July i to December 31, 1940 

PROFIT AND LOSS STATEMENT EXPLAINED 

The profit and loss statement on page 29, while quite elemen- 
tary, has nevertheless enough material for our study at this time. 

The statement in a general way presents in narrative form 
the principal source of income first the gross income, then 
the net income, should there be any return sales or allowances. 
From the net sales income is deducted the Cost of Goods Sold, 



28 FUNDAMENTALS OF ACCOUNTING 

giving a Gross Profit on Sales. From this figure is deducted 
first the Sales Expenses and then the General and Administra- 
tive Expenses, which leaves a Net Income from operations. To 
this figure there is usually added any non-operating income 
which may have been earned during the period, less any non- 
operating expense. The net result is the profit transferable to 
net worth. Probably the best way for a beginner to understand 
the statement is to analyze the terminology and accounts used, 
section by section, in the following illustration. 

NET SALES SECTION 

The principal source of income in a commercial business will 
be recorded in an account entitled Sales. On the books of a 
professional man this account might be called Income from 
Fees. 

There are, of course, other sources of income such as income 
derived from investments, or dividends from stock, or interest 
from bonds or mortgages. Income may result from the sale of 
real estate or other property, or from royalties or rentals. 

On the books of a business organization, however, the Sales 
account usually measures the principal source of income; most 
of the other sources enumerated above would go under the cap- 
tion of non-operating income, and will be treated further un- 
der that caption. In our illustration Mr. Thomas sold during 
the six months' period goods to the extent of $62,000.00. 

The account does not disclose whether the merchandise was 
sold for cash or on account. It simply lists the total contract 
price of all goods sold during the period. 

In many businesses accounts entitled Sales Returns, Sales 
Allowances, or Sales Returns and Allowances will be found. 
These accounts are necessary to record the sales price of goods 
returned or allowances made for one reason or another, the sum 
total of which must be deducted from the Sales account in order 
to determine the net income from sales. On our illustrative 
statement these returns and allowances amounted to $1800.00. 



THE PROFIT AND LOSS STATEMENT 



29 



THE PROFIT AND LOSS STATEMENT ILLUSTRATED 

The following statement is presented as a basis of study. 
JOHN H. THOMAS 

Profit and Loss Statement 
for the six months' period ended Dec. 31, 19 

Gross Income from Sales $62,000.00 

Less Returns and Allowances 1,800.00 

Net Sales $60,200.00 

Deduct the Cost of Goods Sold: 

Inventory on hand June 30 $12,500.00 

Add Purchases $50,800.00 

Less Returns and Allowances 2,100.00 

48,700.00 

Total Available for Sale $61,200.00 

Less Inventory on hand Dec. 31 16,000.00 

Cost of Goods Sold $45,200.00 

Gross Profit $15,000.00 

Deduct Expenses of Operation: 
Selling Expenses: 

Salesman's Salary $ 1,500.00 

Delivery Salary and Expense 1,600.00 

Advertising 800.00 

$ 3,900.00 
General and Administrative Expenses: 

Office Salaries $ 6,000.00 

Rent 500.00 

Telephone and Telegraph 60.00 

Insurance 200.00 

$ 6,760.00 

10,660.00 

Net Profit from Operations $ 4,340.00 

Add Non-Operating Income: 

Interest income 72 .00 

Purchase Discounts 208.00 

$ 280.00 
Less Non-Operating Expense: 

Interest expense 60.00 

Sales Discounts 122.00 

$ 182.00 

98.00 
Net Profit for the Period $ 4,438-00 



THE COST OF GOODS SOLD SECTION 

Cost of Goods Sold is a caption used on a profit and loss 
statement and may or may not be a summary account on the 
books. It is, however, made up of three very important ac- 



30 FUNDAMENTALS OF ACCOUNTING 

counts. The amount in the Inventory account at the beginning 
of the accounting period, to which is added the total amount of 
Purchases of merchandise made during the period. The total 
derived from adding these two factors represents the total 
amount of merchandise available for sale during the period. In 
our illustration the amount is $61,200.00. As a stock of mer- 
chandise must always be kept available for sale, an inventory 
must be computed at the end of the period, and this amount is 
deducted to determine the cost price of goods sold. This sec- 
tion will of course be expanded, as in our illustration, if there 
should be any Purchase Returns or Allowances. A subtraction 
of the cost of goods sold from the net income from sales will 
give the gross profit on sales. In our example the cost of goods 
sold is labeled $45,200.00 and, when this is subtracted from 
the net income from sales $60,200.00, a gross profit of $i 5,000.00 
is obtained. 

OPERATING EXPENSES 

From the gross profit figure, the various expenses of opera- 
tion must be deducted before the net profit from operations may 
be obtained. For managerial purposes these expenses are quite 
frequently separated into Selling Expenses and General and Ad- 
ministrative Expenses. 

SELLING EXPENSES 

Included under this heading should be all accounts which 
measure those expenditures made directly to secure the sales 
income. Accounts such as those listed in our illustrative Profit 
and Loss Statement are the usual clear-cut selling expenses. In 
addition there will be found frequently such accounts as Sales- 
men's Commissions, Freight and Cartage Outward, Wrapping 
Materials, Shipping Cases, Depreciation of Delivery Equip- 
ment, and Delivery Truck Maintenance. 

GENERAL AND ADMINISTRATIVE EXPENSES 

Under this caption, in addition to the accounts in our illus- 
trative statement, will often be found such accounts as Taxes, 
Light Heat and Power, Depreciation of Office Equipment, and 
Depreciation of Buildings. 



THE PROFIT AND LOSS STATEMENT 31 

NON-OPERATING INCOME 

This heading is reserved for accounts which arise from in- 
come derived from operations other than the principal and reg- 
ular operations of the business. 

Another heading quite frequently used in place of Non- 
Operating Income is simply Other Income. Beside the two ac- 
counts illustrated under this heading, we may find accounts 
such as Rental Income or Dividends Received. The former ac- 
count is reserved for income received from rentals, while divi- 
dends received from invested funds should be placed in the 
latter. 

NON-OPERATING EXPENSE 

This caption is frequently employed to head those expense 
accounts which have no bearing on the usual operations of the 
business. Here also another heading, Other Expenses, is fre- 
quently used instead of Non-Operating Expenses. In addition 
to the tw6 accounts listed on our illustration, expense or loss 
accounts arising from extraneous operations may also be listed 
here, as for example: Loss on Sale of Stock, Loss on Sale of 
Real Estate, or losses on sale of any capital assets. 

NET PROFIT SECTION 

The net profit is the final result of the statement and belongs 
to the owners of the business. In a sole proprietary business 
the amount is placed to the credit of the proprietor in his capi- 
tal account, while if a partnership, the net profit must be di- 
vided in accordance with the partnership agreement. On the 
books of a corporation the net profit belongs to the stockhold- 
ers and is transferred to the surplus account. 

ASSET AND EXPENSE DIFFERENTIATED 

In our chapter on the balance sheet, an asset was briefly de- 
fined as " anything of value owned by the business. 77 We had 
as illustration such accounts as cash, land, buildings, machinery, 
and equipment all good tangible assets, in addition to the 
so-called intangibles, such as accounts receivable, patent rights, 
and even good- will. Under the caption Deferred Assets we 
found listed Prepaid Advertising, Prepaid Insurance, Fuel In- 
ventory, Stationery and Supplies. On some of the profit and 



32 FUNDAMENTALS OF ACCOUNTING 

loss statements presented, the student may have noted expense 
accounts with titles very similar to asset account titles, for ex- 
ample: Advertising, Insurance, Fuel, Stationery and Supplies. 

Accounts of this character are known as mixed accounts, be- 
cause they contain in part the elements of an asset, and at the 
same time the qualities of an expense. Let us take, for exam- 
ple, the Fuel account; this account, which represents the amount 
expended for coal, oil, or other fuel, is usually thought of as an 
expense account. 

Often, because of favorable prices, a company will purchase 
a supply of fuel large enough to carry it through its entire sea- 
son. The fuel, coal or oil, has of course all the elements of an 
asset; " something of value owned by the business "; neverthe- 
less, because it was purchased to be consumed in operation of 
the business, it will be charged into the Fuel account and classed 
as an expense. At the close of an accounting period, however, 
when financial statements are being prepared and inventories 
taken as a matter of routine, should there be any fuel on hand, 
this will be measured and valued at cost. This inventory will 
be separated from the expense account Fuel to which it was first 
charged at time of purchase, and when so separated will be 
placed on the books as Fuel Inventory, an asset under the cap- 
tion Deferred Charges. Similarly, should an expenditure be 
made for advertising, and the advertising benefit more than the 
current accounting period, then the unexpired value should be 
determined and this Unexpired Advertising should be separated 
from the expense account Advertising and placed on the bal- 
ance sheet as a Deferred Charge. 

The mechanics of separating these so-called mixed accounts 
into their elements, asset and expense, is done at the end of 
an accounting period by means of adjustment entries and will 
be treated thoroughly in a subsequent chapter. 

At this time, however, we might say that all assets are simi- 
lar to expenses in that they are all consumed in the operation 
of the business, the only difference being the length of time it 
takes to consume the different items. Fuel, under ordinary 
conditions, will be consumed almost immediately, so will sta- 
tionery and supplies; whereas a building may last fifty to sev- 
enty-five years before it will be wholly consumed in the op- 
eration of the business. An auto truck, used for delivery, in 



THE PROFIT AND LOSS STATEMENT 33 

normal use will wear out, or be consumed, in a much shorter 
time, probably three years, while a salesman's automobile may 
not last more than a year before it must be traded for a new 
car. The relative life of an item, then, is one factor used by 
accountants in deciding whether to fix an expenditure as an as- 
set or an expense. The beginning student, however, should 
have little trouble in distinguishing between ordinary routine 
expense and asset accounts. The few mixed accounts, such as 
those just mentioned, are adjusted at the end of the accounting 
period, and the work is usually done by a bookkeeper or an ac- 
countant of experience. 

STATEMENT OF CAPITAL 

Another statement quite frequently required in practice is 
the Statement of Capital. A study of two balance sheets, one 
drawn at the beginning of an accounting period, and one at the 
end, will yield the net increase or decrease in the proprietor's 
capital account ; but what caused the increase or decrease may 
not be apparent because there are several factors which might 
cause an increase or decrease in net worth. The net profit as 
determined by the profit and loss statement will, of course, in- 
crease the owner's net worth. However, the increase or de- 
crease resulting from a comparison of two balance sheets may 
not be equal to the net profit because the proprietor may have 

MR. X 

Statement of Capital 

Capital January 2, 1940 $10,000.00 

Add additional investments: 

February 5, 1940 $1,000.00 

May 10, 1940 2,000.00 

3,000.00 
$13,000.00 
Less Withdrawals: 

June i, 1940 500.00 

$12,500.00 
Add Profit for year ended December 31, 1940 as per 

Profit and Loss Statement 3,010.40 

Capital January 2, 1941 $15,510.40 



34 FUNDAMENTALS OF ACCOUNTING 

made an additional investment, which would of course be an 
addition to his capital account; and, on the other hand, he might 
have reduced his capital account by a withdrawal of funds. 

Where there have been changes in the proprietor's capital 
account during the period, a statement of capital such as that on 
p, 33 may be required. 

This statement is required only when there have been interim 
changes in the proprietor's capital account. However, if his 
investment remains unchanged throughout the accounting pe- 
riod, because there were no additional investments or withdraw- 
als, the statement of capital would not be required. In such a 
case the profit resulting from the operations of the period need 
only be added to the net worth at the beginning of the period 
so as to determine or check the net worth at the close of the pe- 
riod as determined from the application of our fundamental 
rule. 

For example, let us assume that Mr. X has continued his 
business until December of 1940 and has made no additional 
investments or withdrawals of capital funds. Then, on a bal- 
ance sheet drawn December 31, 1940, all that would be re- 
quired is exhibited below under the Net Worth section: 

NET WORTH 

Mr. X. Capital, January 2, 1941 ................... $15,510.40 

Add Profit as per Profit and Loss Statement ........ _ 



_ . 
Net Worth, December 31, 1940 .................. $19,710.90 

This illustration would be part of the balance sheet drawn 
December 31, 1940. The increase in net worth is due entirely 
to a profit on the year's operations. 

The capital statement illustrated would also serve well for 
a partnership, except, of course, that one statement would be 
required for each partner. In partnerships, drawings are often 
limited, and sometimes additional investments may require mu- 
tual consent of the partners; this subject will, however, be 
treated fully in a subsequent chapter. 

STATEMENT OF SURPLUS 

On the books of a corporation, instead of a Statement of 
Capital, we find the Statement of Surplus. This statement is 



THE PROFIT AND LOSS STATEMENT 35 

used to record the interim changes in surplus which may have 
been made during the period. Often this will be a complicated 
statement, because in a large corporation many transactions 
may be made during the accounting period which go directly 
to the surplus account. This statement, therefore, may be a 
very important one to the directors and stockholders of a cor- 
poration. The following example is a simple one intended only 
to show a few of the common changes in surplus which often 
occur in practice. 

THE EXCELSIOR Co., INC. 

Statement of Surplus 
Year Ended December 31, 1940 



Balance, December 31, 1939, per books $25,000.00 

Add: Profit on Sale of X Co. stock (an extraneous 

profit) 600.00 

Profit for year as per profit and loss statement i3,2oo.oo_ 

$38,800.00 
Less: Dividends Declared Jan. 15, 1940 

Preferred: T% on $50,000 . $ 3,500.00 

Common: lo 1 /^ on $100,000 10,000^00 

$13,500.00 
Balance, December 31, 1940 $25,300.00 



THE MANUFACTURING COMPANY PROFIT AND LOSS STATE- 
MENT AND USE OF SCHEDULES ON STATEMENTS 

The profit and loss statement previously illustrated is a form 
which would serve almost any commercial organization except 
a manufacturing company. A profit and loss statement pre- 
pared for a manufacturing company would be very similar ex- 
cept in one section. The Cost of Goods Sold section for any 
organization but a manufacturing company is briefly made up 
as follows : 



36 FUNDAMENTALS OF ACCOUNTING 

COST OF GOODS SOLD 

Beginning Inventory $10,000.00 

Add Purchases $56,000.00 

Less Returns 2,000.00 

Net Purchases $54,000.00 

Add inward freight 1,000.00 

$55,000.00 
$65,000.00 

Less Inventory (new) 12,000.00 

Cost of Goods Sold $53,000.00 

For a manufacturing concern, however, because it manufac- 
tures, rather than purchases the goods it sells, this section would 
be made up, in brief, as follows : 

COST OF GOODS SOLD 

Inventory Finished Goods (old) $ 10,000.00 

Add: Cost of Goods Manufactured, Schedule " A " 150,000.00 

$160,000.00 

Deduct Inventory Finished Goods (new) 15,000.00 

Cost of Goods Sold $145,000.00 



USE OF SCHEDULES ON STATEMENTS 

On the foregoing Cost of Goods Sold section for a manufac- 
turer, note that the Cost of Goods Manufactured calls for a 
schedule. 

The following is a typical schedule: 

SCHEDULE " A " 

Cost of Goods Manufactured 

Inventory Work in Process, Jan. i, 19 $ 15,000.00 

Add: Cost of Raw Materials Used: 
Inventory Raw Materials 

Jan. i $ 8,500.00 

Add, Purchases of Raw Mate- 
rials 70,000.00 

Freight Inward 1,500.00 

$80,000.00 
Less Inventory Raw Materials Dec. 31 10,000.00 

Cost of Raw Materials Used $ 70,000.00 



THE PROFIT AND LOSS STATEMENT 37 

Add: Direct Labor $ 45,000.00 

Manufacturing Expenses: 

Indirect Labor $16,000.00 

Factory Supplies Used 3,000.00 

Light, Heat, & Power 2,400.00 

Depreciation of Machinery . . 4,600.00 

Factory Taxes 1,000.00 

Factory Insurance 2,000.00 

Total Manufacturing Expenses $ 29,000.00 

Total $159,000.00 

Less Work in Process Dec. 31, 19 9,000.00 

Cost of Goods Manufactured $150,000.00 

In the preparation of the balance sheet and the profit and 
loss statement, quite frequently by the use of Schedules it will 
be possible to exhibit, in a condensed form, a complete finan- 
cial statement on one page. Schedules should be used when 
more than five accounts appear under any section, particularly 
if detailed listing would crowd the principal report. For ex- 
ample, the- profit and loss statement might have schedules for 
Selling Expenses and for General and Administrative Expenses. 
On the balance sheet, individual accounts receivable, or pay- 
able, never appear, but for managerial purposes schedules of 
the individual accounts are made up to support the main state- 
ment. Similarly, there might be a schedule prepared for In- 
vestments or Fixed Assets or any other group of similar ac- 
counts where the number will warrant their use. 



QUESTIONS ON THE CHAPTER 

1. What is the purpose of a profit and loss statement? 

2. What do you understand by (a) Expense? (b) Income? 

3. Write a paragraph explaining mixed accounts. 

4. (a) Is it possible to determine the profit or loss made by a 
business from a balance sheet prepared at the end of an accounting 
period? 

(b) Would having the balance sheet for the last period help? 
Explain. 

(c) What effect would withdrawals of capital or additional 
investments have on the profit or loss? 

5. Draw a skeleton form profit and loss statement for a mercan- 
tile company. 

Explain why each section is prepared. 



38 FUNDAMENTALS OF ACCOUNTING 

6. Explain the use of a statement of capital for a sole proprietor. 

7. Explain and illustrate with your own accounts and figures a 
typical " Surplus Statement." 

8. (a) What is Non-Operating Income? 

(b) Name three Non-Operating Income accounts. 

9. (a) What is Non-Operating Expense? 
(b) Name three Non-Operation Expenses. 

10. If you were a banker and were studying the advisability of 
granting a loan, which statement would you prefer the balance 
sheet or the profit and loss statement? Why? 

ir. What is the difference in the headings of the balance sheet 
and those of the profit and loss statement? Is the difference impor- 
tant? Why? 

12. What is a Schedule? Name three, and place five accounts 
under each. 

13. Must the final net profit as determined from the profit and loss 
statement agree with the difference in proprietorship as ascertained 
from a comparison of balance sheets drawn at the opening and close 
of the accounting period? Why or why not? 

14. Why is depreciation an expense? 

15. Explain how Interest may be either an expense or income. 
What is the determining factor? 



PROBLEM MATERIAL 

PROBLEM i 

From the following selected accounts taken from the books of 
John Davidson, at October 31, 1940, prepare a profit and loss state- 
ment: Total Sales $4280.40, Inventory on hand September 30, 1940 
$4289.60, Total Purchases for the month $2218.40, Inventory Octo- 
ber 31, iQ4o $3846.80, Rent $120.00, Advertising $160.00, Salaries 
$420.00, General Expense $128.00, Telephone and Telegraph $16.00, 
Electric Light $12.00, Delivery Expense $208.00. 

Required: A profit and loss statement for the month ended October 
31, 1940. 

PROBLEM 2 

In completing your work for Mr. Daniel Morgan, you prepare a 
profit and loss statement showing the results of his operation for the 
year ended September i, 1940. From a study of the books you learn 
that the total sales of gasoline, oil, and tires, and other miscellaneous 
items was $12,240.00. His stock on hand September i, 1939 was 
$1260.00 and during the year he purchased further items totaling 
$8280.00. At September i, 1940 the stock on hand was valued at 
$1860.00. He paid out $1350.00 for Salaries; $360.00 for Adver- 



THE PROFIT AND LOSS STATEMENT 39 

tising; $60.00 for General Expense items; $30.00 in interest charges, 
while the annual rent payments were $600.00. 

Required: A profit and loss statement for the year ended September 
i, 1940. 

PROBLEM 3 

To complete your work with the firm of Fraser and Thompson you 
are to prepare a profit and loss statement for the year ended October 
i, 1940. An examination of their books reveals the following ac- 
count balances. Total sales were $38,750.60, Return Sales $610.20, 
Inventory, balance October i, 1939 was $2840.00 and at October i, 
1940 was $3600.00. Total Purchases for the year amounted to 
$30,054.00; there were, however, Purchase Returns of $420,00. 
There was $606.09 earned on Purchase Discounts. Total Interest 
Expense was $24.90. Expenses of Operation included the following: 
Salaries $4800.00, Advertising $840.00, Delivery Expense $1900.00, 
Telephone and Telegraph $64.00 and Rent $840.00. 

Required: A profit and loss statement for the year ended October i, 
1940. 

PROBLEM 4 

Mr. H. Rockefeller has been in business for some time. The fol- 
lowing accounts are taken from his general ledger and represent the 
condition of his business at November i, 1940. 

Purchases $28,000.00 

Sales 52,000.00 

Inventory May i, 1940 13,400.00 

Purchase Returns 640.60 

Purchase Discounts 260.00 

Sales Returns 1,600.00 

Sales Discounts 800.00 

Freight & Cartage 920.00 

Advertising 1,600.00 

Salesmen's Salaries 4,280.00 

General Office Salaries 3,920.00 

Cash 12,435.00 

Accounts Receivable 8,245.00 

Accounts Payable 4,900.00 

Reserve for Doubtful Accounts 821.00 

Land & Buildings 24,000.00 

Reserve for Dep. of L. & B 720.00 

Furniture and Fixtures 2,800.00 

Reserve for Dep. of F. & F 560.00 

Notes Receivable 2,000.00 

Interest Income 12.40 

Notes Payable 3,600.00 

Mortgage Payable 10,000.00 

Interest Expense 114.00 

Rockefeller, Capital 30,600.00 

Inventorv Nov. i. IOAO 12.210.00 



40 FUNDAMENTALS OF ACCOUNTING 

Required: From the accounts above you are to prepare: (i) a profit 
and loss statement for the six-months period ended November i, 
1940; and (2) a balance sheet as of November i, 1940, adding 
the profit you determine from the profit and loss statement to Mr. 
Rockefeller's Capital Account. 



PROBLEM 5 

Mr. Daniel Morgan asks you to reconcile his capital account at 
September i, 1940, with that of September i, 1939. You have bal- 
ance sheets as of both dates, also his profit and loss statement for the 
year ended September i, 1940. Upon inquiry you find that Mr. 
Morgan has made no additional investments, but during the year his 
withdrawals totaled $2000.00. 

Required: A statement of capital for Mr. Morgan as of September i, 
1940. 

PROBLEM 6 

Mr. F. Brown asks you to prepare a statement of capital for him 
to prove his capital at December 31, 1940. You have checked his 
records and assembled the following facts. His capital at Dec. 31, 
1939 was $13,419.15. During the year he made the following ad- 
ditional investments: May i, 1940 $800.00, September 15, 1940 
$1200.00, November i, 1940 $1000.00. His drawings were $100.00 
a week, totaling $5200.00 for the year. His Profit and Loss Statement 
for the year ended Dec. 31, 1940, showed a profit of $9240.25. 

Required: A statement of capital for Mr. F. Brown as of December 
31, 1940. 



CHAPTER IV 

THE LEDGER, ACCOUNTS, AND THE TRIAL 
BALANCE 

INTRODUCTION 

The preceding chapters have explained at some length the 
two principal statements used in business. The student at this 
point should have a clear understanding of the five principal 
groups of accounts studied. From his study of the balance 
sheet he should have a good knowledge of the three elements 
or groups of accounts found there: assets, liabilities, and net 
worth. From his study of the profit and loss statement just 
completed he should have a thorough knowledge of the remain- 
ing two principal groups of accounts: expense and income. He 
should also know the few mixed accounts studied, which might 
possibly be considered as a sixth group of accounts. In our 
plan of study we next take a step backward and see where all 
these accounts came from. 

THE LEDGER 

In a set of double entry books there are two types of records 
which must be maintained: books of original entry, or Journals, 
into which the original analysis of the business transactions are 
written, and books of final record or Ledgers. At the present 
time let us concern ourselves with only the latter group. 

The ledger is the principal book of final record, and within 
its bounds is kept every account of the business. 

It may take any of three forms: loose-leaf ledger, bound 
ledger, or card ledger. Each of these forms has certain advan- 
tages, and possibly certain disadvantages; one form will best 
suit one need, while another form will best suit another need. 
The loose-leaf form is superior to the bound type, for the pages 
may be moved about easily. This makes it possible to remove 
the ledger sheets and put them into a bookkeeping machine for 
entries, and then to replace them in their proper place. Ac- 
counts in a loose-leaf ledger which are inactive may easily be 



42 FUNDAMENTALS OF ACCOUNTING 

removed to transfer binders so that the ledger need not be clut- 
tered with a lot of deadwood. 

The bound ledger is almost obsolete, except where there is 
fear that pages may be removed and possibly lost or stolen. 
The bound ledger, of course, cannot be used with bookkeeping 
machines. 

The card ledger is similar to the loose-leaf ledger and has 
all its advantages. The so-called cards vary in weight from 
what might be termed by the layman as heavy " paper " up 
to cardboard. The card ledger is used often when a great many 
entries are to be made at regular or frequent intervals, as in 
the case of an installment house. Cards are easily handled, 
and their greater tensile strength gives them a distinct advan- 
tage over paper sheets. Today visible records are used a great 
deal. These vary considerably in form, their principal advan- 
tage, of course, being accessibility. 



THE GENERAL LEDGER AND USE OF SUBSIDIARY LEDGERS 
AND CONTROL ACCOUNTS 

The ledger may contain relatively few accounts, and may 
well consist of an inexpensive loose-leaf binder to contain the 
ledger sheets. On the other hand a large department store, in 
addition to its many general accounts, may have hundreds of 
thousands of customers' accounts to keep. In this case a bound 
ledger could hardly be considered. Cabinets would contain all 
customers' cards, and be kept in a separate bookkeeping de- 
partment. There modern bookkeeping machines would be uti- 
lized to record the tremendous volume of transactions. Such a 
system would utilize a General Ledger, in which all the princi- 
pal accounts of the store would be kept. The customers 7 ac- 
counts kept in a separate department, as described above, would 
form a subsidiary ledger, which would be controlled through 
a summary controlling account maintained in the General 
Ledger. Often, in a large organization, there might be several 
subsidiary ledgers, in addition to the Customers' or Accounts 
Receivable Ledger described above. Quite frequently there will 
be an Accounts Payable Ledger, and there might be a Mort- 
gage Ledger. 

In fact, in a well set up accounting system the General Ledger 



LEDGER, ACCOUNTS, TRIAL BALANCE 43 

is subdivided any time a group of similar accounts become nu- 
merous enough to warrant such division. For example, a manu- 
facturing concern will often maintain a Machinery and Equip- 
ment Ledger, because it will have so many machines for which 
it feels it is best to maintain separate records. In every case 
when any group of similar accounts is removed from the Gen- 
eral Ledger, a controlling account is replaced to show, in sum- 
mary form, all that is contained in detail in the subsidiary 
ledger. This is because the General Ledger is the principal 
book of final record and all accounts of the business should be 
found within its bounds. If this is not possible, for one reason 
or another, and subsidiary ledgers are maintained, then, as 
shall be subsequently explained, summary accounts to control 
these subsidiary ledgers must be placed in the General Ledger. 

TITLE OF ACCOUNT 

(1) (2) (3) (4) (1) (2) (3) (4) 



In the illustration above, the top of the account is reserved 
for an appropriate heading or title. This title may simply be 
one word such as Cash; or, in the case of a customer's account, 
it might contain in addition to the customer's name, his address, 
and possibly his credit limit with the organization. The im- 
portant rule to remember in naming accounts is to give them a 
title which will describe as accurately as possible what is to be 
kept within the account. The numbers appearing at the head 
of each division of the ruling do not appear on any ruled forms; 
they have been indicated simply as an easy method of identifi- 
cation in our explanation of an account. In the center of the 
page is a three-lined fancy ruling; this separates the two sides 
of an account, the debit from the credit. The debit side of an 
account will always appear on the left side, while the right-hand 
side is always reserved for the credit information. 



44 



FUNDAMENTALS OF ACCOUNTING 



Column i is reserved for the date of the transaction. The 
first part is used for the month and the narrow part for the day 
of the month. The year is written just above the month in small 
figures. After the month is once written it need not be repeated 
for the same month. 

Column 2 is reserved for a very brief explanation. In many 
cases this column is left blank, because the folio number indi- 
cates where a complete explanation of the debit or credit may 
be found; however, many good bookkeepers still use the space 
for such key information as Purchase Order No. , or In- 
voice No. , or the due date on a note. 

Column 3 is sometimes marked " F " or " LF," indicating 
ledger folio, for which this narrow space is reserved. In this 
column is written the page number of the journal from which 
the information was transferred. 

Column 4 is the amount or money column. Here is entered 
the amount of the transaction as indicated in the journal; the 
wider space is for dollars while the narrower is for cents. 

ACCOUNT DEFINED 

In double entry bookkeeping an account may be defined as 
a record kept in the ledger, wherein are recorded financial data, 
classified technically according to debits and credits, pertaining 
to one asset, liability, capital, expense or source of income, for 
which the account is named. 



ILLUSTRATION OF A TYPICAL ACCOUNT AND ITS FUNCTION 

CASH 



1940 








1940 








Oct 

Nov 


i 
i 
i 
3 1 

i 


Balance 
Cash Sales for day 
Received on acc't. 
Sundry Receipts 
for the Month 

Balance 


V 

3 
7 

35 

v/ 


2500 
150 
275 

6500 


00 

oo 
oo 

oo 


Oct 


I 
I 
9 
15 
3i 


Rent for Month 
Salary for week 
Express & Cartage 
Advertising 
Sundry disburse- 
ments 
To Balance 


i 

2 

9 

12 

18 

v/ 


IOO 

300 
65 
135 

5000 

3825 


oo 

00 

oo 
oo 

00 

oo 


9425 


oo 


9425 


00 


3825 


oo 







Cash is a typical asset account. Listed on the left or debit 
side is the original cash invested, or the cash balance as of a 



LEDGER, ACCOUNTS, TRIAL BALANCE 45 

particular date, as in the illustration above, and all subsequent 
receipts of cash. On the opposite or credit side are listed all 
disbursements of cash. The account above has been formally 
balanced. The balance $3825.00 was written in on the credit 
side simply to balance; this is sometimes written in red ink. 
The balance is brought down on the debit side where it belongs, 
and is the balance of cash at the start of the new month. This 
balance indicates that there is on hand or in the bank $3825.00 
worth of cash to the credit of the company. Just why the cash 
account is debited to show increases, and credited to show de- 
creases, is the theme of our next chapter. 



BALANCE TYPE OF ACCOUNT 

Illustration No. i 

Another form of account in somewhat common use is known 
as the balance type, and employs three money columns instead 
of two, as in the standard form. The following is an illustration 
of the balance type of ledger account: 



Name: Fred Smith 
Address: 2 5 James Road 
Boston, Mass. 



Credit Limit: $200.00 



Date 


Item 


F 


Debits 


Balance 


Credits 


F 


Items 


Date 


1 u) ~ 
April 


s 


Sale 




60 


00 


60 


oo 


























15 


oo 


45 


00 


7 


Cash 


April 


10 


May 


i 


Sale 


21 


20 


oo 


35 


oo 
















25 


Sale 


30 


40 


oo 


75 


oo 


























25 


oo 


50 


00 


25 


Cash 


June 


i 



This form of ledger sheet is used quite extensively for per- 
sonal accounts, particularly those of customers. The heading 
includes space for the customer's name and address and very 
often includes other data which will aid in handling the account 
in such matters as the customer's credit rating or credit limit 
as fixed by the credit department. 

The balance type of account is superior to the standard form 
for customers' accounts because the balance due from the cus- 
tomer is available immediately. This form is very often used 
where bookkeeping machines are in use. The bookkeeper keeps 



46 FUNDAMENTALS OF ACCOUNTING 

a carbon copy of the account which serves at the end of the 
month as a statement of the account. This saves a great deal 
of time in mailing statements to customers. When an account 
runs over a period of months, a new second sheet is inserted each 
month and only the balance due is copied in, after which only 
current items will appear. The account always remains in the 
ledger and each month a copy is mailed to the customer. By 
having envelopes already stamped and addressed, it is a very 
simple matter to get the monthly statements in the mail on the 
morning of the first day of the month. 

The following ruling is another form seen frequently in prac- 
tice. The superiority of this form over the standard ruled ac- 
count is that it provides two columns for recording the balance 
of the account. As accounts usually have their balance on one 
side, in practice only one of the balance columns would be used 
for each type account. For example, as we shall see in the next 
chapter, all assets will have debit balances as in the case of the 
cash account previously illustrated, and all liabilities will have 
credit balances. 



BALANCE RULING 
Illustration No. 2 



NAMC 

AOOMC** 
TOWN 



ACCOUNT N B-1346 
MEET NO. 1 



DIBIT \/ CREDIT 



The forms already illustrated are forms frequently used in 
business. Any special form, however, may be designed to meet 
peculiar requirements. No matter in what form the account 
may be, the fundamental principle of the account is always 
the same. 



LEDGER, ACCOUNTS, TRIAL BALANCE 47 

SOURCE OF ENTRIES 

Entries in the ledger come from journals wherein are written 
the transactions in original form. The process of transferring 
the entries from the journals to the ledger is known as posting. 
In the journals the entries are analyzed into their proper form, 
of debit and credit, or series of debits and credits. In all cases 
in the journal the transactions result in total debits equalling 
total credits. Since this equilibrium is established in the jour- 
nal, and since the debit and credit postings in the ledger equal 
the debits and credits in the journal, the only result can be a 
balance in the ledger. For, if equals are posted in the same 
order, it necessarily follows that equals will result in the ledger. 

THE TRIAL BALANCE 

A trial balance in double entry accounting may briefly be de- 
scribed as a list of the balances of accounts taken from the 
ledger, classified in two columns as debit and credit balances, 
the totals of which should be equal. 

In a simple set of books where few entries are made and no 
complicated journals are used, there should be very little diffi- 
culty in keeping the books in balance. In larger businesses, 
where more complicated systems of books of original entry are 
employed, the posting is not so simple, and quite often errors 
will creep into the ledger and will appear in the trial balance. 

The beginning student may often find the totals of his trial 
balance not equal. This may be true until he has gained experi- 
ence through practice. A trial balance out of balance indicates 
that errors have been made somewhere, but nothing more. As a 
matter of fact, even when the totals are equal, the beginning 
student cannot be sure that no errors have been made. If com- 
plementary errors are made in the journal and posted properly, 
or if double posting of a correct entry is made, the trial balance 
will still reveal total debits equal to total credits. But the errors 
are there and in such a case must be located because the ledger 
would not reflect the true financial condition of the business. 

The first step in preparing the trial balance is to be certain 
that all journal entries have been posted, and posted once only. 
Next, the money columns (debit and credit) are totaled in the 



48 FUNDAMENTALS OF ACCOUNTING 

ledger with a fine pencil. This is usually kept up from day to 
day in the form of a running total. As each account is footed, 
the balance is extracted by subtracting the smaller amount from 
the greater and writing in small pencil figures the resulting bal- 
ance on the greater side just next to the last entry. The next 
step is to copy down on two-column journal paper the name of 
every account having an open balance, and to list in the proper 
column the debit or credit balance of each such account. This 
may be done by hand or typed, and the adding machine used to 
total the columns if they are lengthy. If the purpose is merely 
to prove the ledger in balance, a satisfactory method is to run 
off on the adding machine first the open debit balances and then 
the credit balances, disregarding account names. 

When the ledger is balanced, it is well to mark the letter of 
the month alongside the balance, as the starting place for subse- 
quent investigation in case of future error. If this is done, only 
the current entries will have to be checked in order to locate any 
errors which may appear in a subsequent trial balance. It is 
good practice to preserve monthly trial balances for future use. 



THE TRIAL BALANCE BOOK 

Because trial balances are important, it is a good practice 
to keep these rather carefully. This is often done in practice by 
the use of an auxiliary record known as the trial balance book. 
This book, however, is not part of the accounting system proper. 
The usual form is a book into which is typed the names of all 
accounts kept in the ledger, leaving a few blank lines for new 
accounts. The page would contain twelve money columns, and 
thus be good for six months; or a twenty- four-column form 
could be used for twelve monthly trial balances. 



FORMALLY BALANCING ACCOUNTS 

Accounts are usually balanced in a formal manner only once 
each year unless there is some special occasion that necessitates 
it (such as the death of a partner, business consolidation, etc.). 
Monthly statements do not require that the accounts be formally 
balanced. The following illustration presents the formal bal- 
ancing of a customer's account: 



LEDGER, ACCOUNTS, TRIAL BALANCE 49 



FRED SMITH 



April 


5 


Sale 




60 


00 


April 


10 


Cash Part Pmt. 




4S 


OO 


May 


i 


Sale 




20 


oo 


June 


i 


Cash Part Pmt. 




SO 


oo 




25 


Sale 




40 


oo 






To balance 




2S 


oo 










120 


oo 










120 


00 


June 


30 


Balance 
















. 


- 






brought 
























down 




25 


oo 















All accounts are balanced this way, usually once a year. For 
monthly purposes, however, the accounts are merely footed, and 
their balances indicated in small figures, usually in pencil. 



THE 



LEDGER ACCOUNT 



In practice work, particularly on the blackboard, the formally 
ruled ledger account will be dispensed with and the so-called 
skeleton or " T " account substituted, simply to save time. 



This form may be utilized by the student in a few of his ex- 
ercises, although it cannot be emphasized too strongly that for- 
mally ruled paper makes for neatness and exactness too. In 
actual practice, untidy work cannot be tolerated. 

THE LAYOUT OF A LEDGER 

The science of accounting utilizes system to its highest pos- 
sible degree. The layout of a ledger, therefore, should follow a 
definite order. In practice this order may vary, but a definite 
classification of accounts will be used in every system worthy 
of the name. 

ILLUSTRATION OF CLASSIFICATION 

The following illustration is presented, merely as a sample 
of what can be done, rather than as a model to be used by any 
or all business organizations, because there are particular prob- 



So FUNDAMENTALS OF ACCOUNTING 

lems which must be solved to meet particular needs for indi- 
vidual companies and therefore the ideal account classification 
must be " custom built." 



CLASSIFICATION OF ACCOUNTS 



A. Assets: 

a. Current Assets: 

1. Cash 

2. Notes Receivable 

3. Accounts Receivable 

4. Inventories 

5. Temporary Investments 

b. Fixed Assets: 

1. Office Fixtures 

2. Machinery and Equip- 

ment 

3. Land 

4. Buildings 

5. Delivery Equipment 

c. Deferred Charges: 

1. Prepaid Insurance 

2. Prepaid Advertising 

3. Coal Inventory 

4. Postage Unused 

d. Other Assets: 

1. Good-will 

2. Patent Rights 

B. Liabilities: 

a. Current Liabilities: 

1. Taxes Payable 

2. Wages Payable 

3. Notes Payable 

4. Accounts Payable 

5. Deferred Credits to In- 

come 

b. Fixed Liabilities: 

1. Mortgage Payable 

2. Bonds Payable 

C. Reserves for: 

1. Doubtful Accounts 

2. Depreciation of Buildings 

3. Depreciation of Machin- 

ery & Equipment 

4. Depreciation of Delivery 

Equipment 



D. Net Worth Accounts: 

1. Capital Stock 

2. Surplus 

E. Sales Group: 

1. Sales 

2. Returned Sales 

3. Sales Allowances 

F. Cost of Goods Sold Group: 

1. Purchases 

2. Purchase Returns 

3. Freight & Cartage Inward 

G. Selling Expenses: 

1. Advertising 

2. Salesmen's Salaries 

3. Traveling Expense 

4. Delivery Expense 

a. Drivers' Salaries 

b. Depreciation of Deliv- 

ery Equipment 

c. Gas & Oil 

d. Repairs 

H. General & Administration Ex- 
penses: 

1. Rent 

2. Taxes 

3. Light, Heat, & Power 

4. Insurance 

5. Office Salaries 

6. Postage 

7. Telephone and Telegraph 

8. General Expense 

I. Non-Operating Income 

1. Purchase Discounts 

2. Interest Earned 

3. Rental Income 

J. Non-Operating Expense 

1. Sales Discounts 

2. Interest Expense 



In the classifications above the different groups were coded 
by use of Capital Letter, no regard being made of the groups 
except sequence. Sometimes C. A. may be used to designate 



LEDGER, ACCOUNTS, TRIAL BALANCE 51 

Current Assets; F. A., Fixed Assets. The separate accounts 
making up the groups may then be numbered as above. The 
decimal system numbers the groups, and then by use of a deci- 
mal point marks off the separate accounts of a group as: 1.1 
might designate the cash account, 2.1 office fixtures. The stu- 
dent can readily see how variation might be adopted and similar 
coding used to advantage. No attempt is made here to give an 
exhaustive treatment on the coding of accounts. Several cost 
accounting texts devote considerable space to this topic. The 
foregoing merely illustrates the possibilities of coding and classi- 
fying accounts. When such a classification is followed, the gen- 
eral ledger is laid out following this order, and a trial balance pre- 
pared from such a ledger greatly facilitates the preparation of 
the balance sheet, and the profit and loss statement. 

The classification for the balance sheet given above follows 
what is known as the order of liquidation, where the most liquid 
assets are listed first, followed by the fixed or permanent assets. 
On the liability side of the balance sheet the same order is 
followed. 



QUESTIONS ON THE CHAPTER 

1. Define: (a) account, (b) ledger, (c) trial balance. 

2. Rule the standard form of account, and illustrate with some 
account with which you are familiar. 

3. If the totals of the debit and credit side of a trial balance are 
equal, is that positive evidence that the work for the period has been 
done correctly? Explain. 

4. What should the title of an account indicate? 

5. Has the balance form of ledger account any advantage over the 
standard form? Explain. 

6. Explain why the ledger should always be in balance. 

7. Explain the procedure of taking a trial balance. 

8. When are accounts formally balanced? 

9. What is the purpose of a Trial Balance book? 

10. What is the use of the " T " ledger account? 

11. Why should a ledger be laid out in a definite order? Discuss 
fully. 

12. Explain the process of posting. 

13. What do you understand by " footing " an account? 

14. Mention two bookkeeping errors which a beginning student 
might make, which would not throw the ledger out of balance, and 
therefore not be revealed by a trial balance. 



52 FUNDAMENTALS OF ACCOUNTING 

15. What rule should be applied in naming an account? 

16. Explain the functions of a Cash Account. 

17. Explain the use of the folio column in the ledger account. 



PROBLEM MATERIAL 

PROBLEM i 

Mr. J. Harvey had a cash balance of $1242.10 at November i, 
19 , and had the following cash transactions during the month of 
November. November i, paid one month's rent $100.00; Novem- 
ber 3, paid salaries $180.00; November 4, received a check from Mr. 
T. Clark $116.00 and paid the monthly telephone bill $16.00. No- 
vember 5, received a check $210.00 from Mr. J. Jones. November 8, 
paid $25.00 for postage and received a check $114.40 from Mr. F. 
Smith. November IT, paid Blouth and Co. account in full $940.00, 
received $195.80 from Mr. Brown. November 16, a check was re- 
ceived from M. H. Clews $300.00. November 17, paid salaries 
$180.00. November 18, a check was received from S. Metz, his ac- 
count in full $589.00. November 21, gave a check for advertising 
$40.00; November 24, received a check from L. Cohen $210.00, and 
sent a check to Cooper Co. $480.00. November 29, a check was re- 
ceived from S. Steel $118.20. November 30, paid salaries $180.00; 
the cash sales for the month totaled $564.06. 

Required: Draw a " T " account for Mr. Harvey. Enter the No- 
vember i balance, list the cash receipts and disbursements given 
above and balance the account, as in the illustrations on page 44. 

PROBLEM 2 

Mr. Thomas Rowland is one of your customers. You have made 
the following sales to him during the year. January 2, $150.00; 
February 7, $120.00; March 27, $160.00; April 4, $210.00; May 
15, $180.00; July 17, $200.00; September 2, $190.00; October 15, 
$240.00; November n, $260.00 and December 5, $320.00. During 
the same period you have received the following checks from Mr. 
Rowland. January n, $150.00; February 15, $120.00; April 15, 
$370.00; June 2, $180.00; September 12, $390.00; October 25, 
$240.00; November 22, $260.00. 

Required: Prepare a standard ruled ledger account and enter the cus- 
tomer's transactions as given above. Balance and rule the account 
as of December 31, similar to the illustration on page 49 of your 
text. 

PROBLEM 3 

In your business you have made the following purchases from the 
New York Wholesale Company. January 4, $1600.00; March 9, 



LEDGER, ACCOUNTS, TRIAL BALANCE 53 

$2000.00; May 6, $2200.00; June 12, $800.00; September 2, 
$1800.00; November 6, 2840.00. 

Your payments during the same period have been as follows: 
January 13, $1600.00; March 18, $2000.00; May 15, $2200.00; June 
12, $800.00; September n, $1800.00. 

Required: Prepare a standard ruled account for the New York Whole- 
sale Co. as it should appear in your ledger. Purchases are to be 
listed as credits and payments made to the New York Wholesale 
Co. listed as debits. Rule and balance the account as of Decem- 
ber 31. 

PROBLEM 4 

At December 31, the ledger of John Hoag reveals the following 
accounts and balances. Cash debit balance $5350.00; Notes Receiv- 
able debit balance $3000.00; Purchases debit balance $0000.00; 
Thomas Rowland debit balance $320.00; James Smith debit balance 
$600.00; Frank Thomas debit balance $810.00; Samuel Cohen debit 
balance ,$200.00; Merchandise Inventory debit balance $4000.00; 
New York Wholesale Co. credit balance $2840.00; Trenton Whole- 
sale Co. credit balance $1620.00; Philadelphia Co. credit balance 
$1440.00; Sales credit balance $10,000.00; Land and Buildings debit 
balance $10,000.00; Mortgage Payable credit balance $6000.00; 
John Hoag Capital credit balance $6380.00; Notes Payable, credit 
balance $2000.00. 

Required: Given the foregoing accounts, list the accounts and bal- 
ances as debits and credits in a trial balance. 



PROBLEM 5 

The following accounts were taken from the ledger of F. Marshall 
at November i, 1940. Accounts Receivable debit $16,000.00; Ac- 
counts Payable credit $18,000.00; Purchases debit $24,630.20; Sales 
credit $28,900.60; Purchase Returns credit $420.40; Sales Returns 
debit $540.00; Purchase Discounts credit $294.00; Sales Discounts 
debit $124.00; Salaries debit $3450.00; Insurance Expense debit 
$916.00. Inventory May i, 1940 debit $6890.80; Notes Receivable 
debit $2000.00; Notes Payable credit $4800.00; Mortgage Payable 
credit $12,000.00; Interest Expense debit $216.00; Interest Income 
credit $148.00; Cash debit $3280.00; Advertising debit $690.00; 
Delivery Equipment debit $3600.00; Land and Buildings debit 
$18,000.00; Taxes debit $1200.00; F. Marshall Capital credit 
$16,974.00. 

Required: Given the accounts above, list the accounts and balances as 
debits and credits in a trial balance. 



CHAPTER V 
FUNDAMENTALS OF DEBIT AND CREDIT 

INTRODUCTION 

If we were to trace the origin of the terms debit and credit, we 
should find that they come from the Latin, debit from dcbitum 
meaning debt, and credit from credere meaning believe or trust. 
These meanings were significant in the days of single entry 
bookkeeping, when most accounts were kept with persons. It 
was then quite satisfactory to say " We debit to show a person 
in our debt/' and " We credit a person when he trusts us." 

Today, however, the terms debit and credit have a more defi- 
nite and limited meaning. As we saw in the last chapter, an 
account has two sides, debit and credit. In double entry book- 
keeping, the left-hand side of the account is reserved for record- 
ing debits, as the right-hand is similarly reserved for recording 
credits. The terms debit and credit are also used to indicate 
changes, increases or decreases, which may take place in ac- 
counts. While each account will have the same form, and 
debit information will always be placed on the left-hand side 
of every account and credit information always placed on the 
right-hand side of the account, the debit and credit sides of each 
different group of accounts will have a different significance. 
As we shall learn presently, the debit side of an asset account is 
reserved to register increases, and the credit side, decreases. 
Similarly, since liability accounts are just the opposite to asset 
accounts, the two sides will have (logically) exactly the opposite 
meanings. For asset ownership claims, liabilities and net 
worth accounts the credit side is always reserved to register in- 
creases, while the debit side is always used to record decreases. 

FUNDAMENTAL RULE FOR DOUBLE ENTRY 

In double entry bookkeeping, the only system used in modern 
business, each transaction when properly analyzed will always 
reveal a twofold exchange in values. For instance, suppose a 
company were to buy a new delivery truck for $1000.00. In 
accounting for this transaction we would say there had been an 

54 



FUNDAMENTALS OF DEBIT AND CREDIT 55 

equal exchange in values. The purchaser received a truck but 
gave up one thousand dollars. The proper accounting for this 
transaction would require the use of two accounts, an automo- 
bile truck account and a cash account; and, as we shall see 
presently, the auto truck account will be debited (to record an 
increase in an asset), while the cash account will be credited 
(to record a decrease in another asset). The monetary values 
in each instance being equal (one thousand dollars), the ac- 
counting result is a debit of $1000.00 offset by an equal credit 
of $1000.00. This fundamental rule of equal debit and credit 
never varies, no matter how complex he transaction may seem. 
The basic rule must always prevail; and, when all factors are 
considered, the net result will be debit or debits, the totals of 
which must be equaled by one or more credits, the total of which 
must again be equal. This rule may never be violated. 



REAL AND NOMINAL ACCOUNTS 

Before we progress further in an attempt to evolve the rules 
which are now in use in double entry bookkeeping, it will be well 
to explain briefly the relation between the several groups of ac- 
counts. This understanding will be helpful in explaining the 
rules for debiting and crediting. The term real account is an 
expression long in use to describe balance sheet accounts, and 
was probably first used because such accounts are the more 
permanent accounts, and are used to measure the true value of 
the business. On the other hand, the term Nominal accounts, 
also in use for many years, designates expense and income ac- 
counts. The term was first used, no doubt, because these 
accounts are of a temporary nature. They are used to gather 
the expenses and income for a period, after which they are 
closed, and the net result, a profit or a loss, transferred to the 
proprietor's capital account. The accounts thus cleared are 
made ready for use again in the next accounting period; there- 
fore, because of their temporary nature, the term nominal was 
no doubt applied to these two groups. 

Some students of accounting have gone so far as to say that 
there are only three groups of accounts: Asset, Liability, and 
Net Worth accounts. They say that Nominal accounts, in fact, 
are only temporary subdivisions of the proprietor's capital ac- 



5 6 FUNDAMENTALS OF ACCOUNTING 

count. While we recognize the truth of this statement of pure 
theory, and will utilize this fact in presenting the rules for debit- 
ing and crediting, we must nevertheless recognize the impor- 
tance of nominal accounts and grant to them the dignity of 
separate groups. 

CHART OF ACCOUNTS 

The chart illustrated below is to be used as an aid in pre- 
senting the rules for debiting and crediting: 

CHART OF ACCOUNTS 
All Accounts 





Ke'al 


Nominal 




or 






or 




Balance Sheet 


Accounts 
> 


Profit and Loss 
1 - 


Accounts 

-> 


1 




1 


1 




^ 


ASSETS 


LIABILITIES 


EXPENSE 


INCOME 


NET WORTH 


Normally 
Debit Balances 


Normally 
Credit Balances 


Normally Normally 
Debit Balances Credit Balance 


Debited to show Credited to show 


Debited to show Credited to sho 


increases 




increases 


increases 




increases 


Credited to show Debited to show 


Credited to show Debited to sho 


decreases 




decreases 


decreases 




decreases 



A study of the chart above indicates that all accounts may be 
divided into real and nominal accounts; and also that these two 
major divisions are again divided; the real accounts are sep- 
arated into Assets on one side and, directly opposite, Liabilities 
and Net Worth. Note also that the Nominal Accounts are 
divided in a similar manner: Expense on one side and, directly 
opposite, the Income group. Note too that this is the relation- 
ship which was presented and explained in our first two chapters. 



RULES FOR DEBITING AND CREDITING ASSETS 

On the above chart under each group is listed the normal 
balance for each type of account. Assets have normally debit 
balances. By that we mean, excepting abnormal conditions 
in a business, because of the long established method of debit- 



FUNDAMENTALS OF DEBIT AND CREDIT 57 

ing and crediting accounts; asset accounts must always have 
their balance on the debit side, i.e., the debits must exceed 
the credits. For example, we shall presently see that asset ac- 
counts are debited to show increases, and credited to show 
decreases; therefore, taking the cash account as a typical asset, 
the debits or increases from receipts must always exceed the 
credits or decreases from disbursements. As the cash account 
usually represents the condition of the bank account, one can 
readily see how impossible it would be, in actual practice, to 
have a credit balance in the account. Such an abnormal sit- 
uation would represent an overdrawn bank account, and even 
the beginning student can recognize what a slim chance the 
business man would have of maintaining this position for any 
length of time. 

In any science a beginning point must be established and used 
as a basis of the demonstration. In our case, starting with cash 
as a typical asset account, we shall ask our readers to accept as 
true just one point to begin with: namely, that to register in- 
creases in asset accounts we debit the account. As a matter of 
fact, there is no reason, except long established custom, why 
debits must be used to register increases; we could just as well 
show increases with credits. But if we did this, because our 
science is a very logical one, we should have to reverse every- 
thing else. We should have to show, for instance, decreases in 
assets as debits. Since absolutely nothing would be gained, no 
one would think of making such a change and upsetting a cus- 
tom of such long standing. 

With our first point taken for granted namely, that in asset 
accounts increases are registered with debits logically, the op- 
posite side of the account or credit side should be reserved for 
recording decreases. Thus we have our first rule: for asset 
accounts: Record all increases on the Debit side and all de- 
creases on the Credit side. 



RULES FOR DEBITING AND CREDITING LIABILITY AND 
NET WORTH ACCOUNTS 

Inasmuch as liability and net worth accounts as a group are 
directly opposite to the asset group just studied, one would 
expect to find the rules for debiting and crediting in these groups 



58 FUNDAMENTALS OF ACCOUNTING 

exactly opposite to those for assets, and that is the very sit- 
uation. To show increases in a liability or net worth account, 
you credit; while to show decreases, you debit. The rules for 
debiting and crediting liability and net worth accounts are ex- 
actly the same, because these two groups of accounts, although 
legally quite different, are similar as far as other qualities are 
concerned. 



RULES FOR DEBITING ASSETS, LIABILITIES AND NET WORTH 
APPLIED AND ILLUSTRATED 

(A) Transactions Analyzed 

Recalling our fundamental rule of double entry, " For every 
debit we must have an equal credit," and the rules for debiting 
and crediting Assets, Liabilities and Net Worth just presented 
they may now be restated in their shortest form : 

Assets Liability and Net Worth 

+ = Dr. + = Cr. 

= Cr. = Dr. 

Let us now put these rules to use with a few transactions in- 
volving three types of accounts. 

Transaction No. i. Suppose Mr. B. Black wishes to start 
in business and invests $5000.00 

The asset Cash is increased, while Mr. Black's Capital Ac- 
count is also increased. Applying our rules, this will result in 
a debit to Cash to register the increase, and a credit to Black's 
Capital Account to show the establishment of the capital ac- 
count, which is an increase from zero to $5000.00. 

Transaction No. 2. Suppose Mr. Black now purchases some 
store equipment for $800.00 cash. Here the asset Store Equip- 
ment has been increased, but the asset Cash has been decreased. 
This must therefore result in an increase or debit to Store Equip- 
ment and a credit to Cash. 

Transaction No. 3. Suppose Mr. Black borrows $1000.00 
from the bank on his note, payable in sixty days. Here an asset, 
Cash, has been increased, but a liability in the form of Notes 
Payable is also increased. This will result in a debit to Cash, 
and a credit to Notes Payable. 



FUNDAMENTALS OF DEBIT AND CREDIT 59 

Transaction No. 4. Suppose Mr. Black purchases a light de- 
livery truck for $1000.00, paying $400.00 in cash and tht bal- 
ance on finance notes. This will increase his assets, Delivery 
Equipment, which will be debited, while Cash has been de- 
creased $400.00 and must therefore be credited; the other 
$600.00 is credited to the Notes Payable account, because in 
signing these finance notes a liability is increased. This is our 
first compound entry, one debit offset by two credits, the totals 
of which, however, must be equal. 

Transaction No. 5. Suppose Mr. Black purchases a building 
containing a store in which he will conduct his business. The 
contract price is $3000.00, for which Black pays out $1000.00 
in cash and gives a mortgage for the balance. This transaction 
will increase Mr. Black's assets, Land and Buildings, $3000.00. 
His cash has been reduced $1000.00, while a new liability, 
Mortgage Payable, has been established for $2000.00, resulting 
in another compound entry. A debit to Land and Buildings, 
$3000.00, and a credit to Cash, $1000.00, and a credit to Mort- 
gage Payable, $2000.00. 

(B) Transactions Posted 

In order to complete our illustration, let us post these five 
transactions to the accounts indicated in the analysis above, 
using transaction numbers for folio references. 

Dr. + CASH Cr. - 



(i) Investment 

(3) Borrowed on note 



Dr.+ 



$5000.00 

IOOO.OO 



(2) Store Equip. 

(4) On Auto 

(5) L. & B. 



STORE EQUIPMENT 



$ 800.00 

400.00 

1000.00 



Cr. - 



(2) Purchased for cash 



Dr.+ 



$ 800.00 



DELIVERY EQUIPMENT 



Cr. - 



(4) Purchase 



$1000.00 



60 FUNDAMENTALS OF ACCOUNTING 

Dr. + LAND AND BUILDING Cr. 



(5) Purchase 



Dr. - 



$3000. oo 



B. BLACK, CAPITAL 



Cr.+ 



(i) Cash invested 



Dr. - 



NOTES PAYABLE 



Cr.+ 



(3) Borrowed on note 

(4) Finance notes 



Dr. - 



MORTGAGE PAYABLE 



$1000.00 
600.00 



Cr.+ 



(5) On building 



$2000.00 



If we were now to balance the accounts above we should get 
the following trial balance : 

Cash $3800.00 

B. Black, Capital $5000.00 

Notes Payable 1600.00 

Store Equipment 800.00 

Mortgage Payable 2000.00 

Delivery Equipment 1000.00 

Land & Building 3000.00 



$8600.00 $8600.00 

Thus we have put our rules affecting real accounts to work 
for us and have noticed the fundamental rule of double entry 
also proved in application. 



RULES FOR DEBITING AND CREDITING NOMINAL ACCOUNTS 

It was stated in the first part of this chapter that nominal 
accounts are often thought of as temporary subdivisions of the 
proprietor's capital account. We shall now put this truth to 



FUNDAMENTALS OF DEBIT AND CREDIT 61 

work for us in demonstrating the rules for expense and income, 
and to show the relationship which does exist between nominal 
accounts and the proprietor's capital account. 

If we should admit, even for the sake of argument, that nomi- 
nal accounts may be considered part of the proprietor's capital 
account, then expenses would reduce capital, and income would 
tend to increase capital; and over a period of time if a man's 
income were greater than his total expenses, his capital would 
increase. The proprietor's account would then appear as 
follows : 

Dr. B. BLACK, CAPITAL Cr. + 



Purchases 


$1800.00 


Investment 


$5000.00 


Taxes 


140.00 


Sales 


2400.00 


Insurance 


100.00 


Rental Income 


200.00 


Salaries 


500.00 


Interest Income 


10.00 


Interest Expense 


60.00 







A summary would indicate for the current period a gain of 
$10.00 which would increase Mr. Black's capital to $5010.00. 
This profit would be increased by an adjustment for inventory, 
but for our present discussion this is not important. 

This manner of determining the proprietor's profit or loss, 
although correct in fundamental theory, is, however, neither 
practicable nor desirable, because such procedure would clutter 
the capital account with much miscellaneous detail. The few 
expense and income items used in the foregoing account are 
merely typical. If all expenses and income items were entered 
in the capital account, the result, when the time arrived to close 
the books, would be of little value. It would lack the important 
element of classification. We must, therefore, give to expense 
and income the dignity of separate accounts. 

Nevertheless, the illustration should make it clear that ex- 
penses decrease capital, and income increases it. The rules for 
debiting and crediting the capital account, it will be recalled, 
briefly stated, were : 

To increase, credit the capital account. 
To decrease, debit the capital account. 

Therefore, if expenses decrease capital, expense accounts 
logically should have debit balances; and income accounts, since 
they increase capital, logically should have credit balances. If 



62 FUNDAMENTALS OF ACCOUNTING 

the student will again glance at the Chart of Accounts, he will 
observe this condition. 

Expense and income accounts are primarily one-sided ac- 
counts. The rules for debiting and crediting expense and in- 
come accounts may be summarized briefly, thus: 

To increase an expense account, debit. 
To decrease an expense account, credit. 
To increase an income account, credit. 
To decrease an income account, debit. 

TRANSACTIONS INVOLVING EXPENSE, INCOME, AND 
OTHER ACCOUNTS 

Transaction Nc, 6. Suppose Mr. B. Black purchased during 
his first month's business merchandise totaling $1800.00, on ac- 
count. Here an increase in the expense Purchases will result in a 
debit, while taking the merchandise on credit will result in an in- 
crease in the Accounts Payable, and therefore a credit. 

Transaction No. 7. Suppose Mr. Black paid $i 40.00 in cash 
for taxes due on his building. This transaction increases an 
expense and is therefore debited to the Taxes account, and is 
credited to the Cash account because the fund of cash is reduced. 

Transaction No. 8. Suppose Mr. Black collected $200.00 
rental income from tenants on floors above his store. This is 
an increase in his asset Cash and at the same time an increase 
to the Rental Income account; a debit to Cash and a credit to 
Rental Income. 

Transaction No. 9. Suppose Mr. Black paid $100.00 foi 
insurance on his building and stock. This transaction de- 
creases his fund of cash and at the same time increases his ex- 
penses in form of insurance. Therefore a debit should be re- 
corded in the Insurance account and a credit to the Cash account. 

Transaction No. 10. Suppose Mr. Black paid $500.00 as sala- 
ries for the month. This transaction also reduces the fund of 
rash, and at the same time increases an expense, Salaries, by an 
equal amount. Therefore, a debit to Salaries^ and a credit to 
Cash should be recorded. 

Transaction No. n. Suppose during the month Mr. Black 
had sales in total of $2400.00, which, let us suppose, was made 



FUNDAMENTALS OF DEBIT AND CREDIT 63 

up of $1600.00 in sales on account and $800.00 in cash sales. 
These sales transactions in summary then would result as fol- 
lows: an increase in asset, Cash $800.00, an increase in asset 
Accounts Receivable, $1600.00; while at the same time Sales 
Income is increased $2400.00. 

A compound entry would result: a debit to Cash, $800.00, 
and a debit to Accounts Receivable, $1600.00, offset by a credit 
to the Sales account in total $2400.00. 

Transaction No. 12. Suppose Mr. Black paid $60.00 inter- 
est. This transaction illustrates a reduction in cash due to in- 
terest expense, therefore a debit to Interest Expense and a 
credit to Cash. 

Transaction No. /j. Suppose Mr. Black collected $10.00 in 
cash as interest income. This transaction, the opposite of 
No. 12, indicates an increase in the Cash account and at the 
same time an increase in the Interest Income account. The 
resulting debit would be to Cash, and the credit to Interest 
Income. 



TRANSACTIONS POSTED 

In order to complete our illustration, the accounts as we left 
them after transaction 5 are reproduced below, together with 
the new transactions, 6 through 13. Again transaction numbers 
have been used as folio references, and the student should trace 
through each transaction. 



Dr. 



CASH 



Cr. - 



(i) Investment 


$5000 oo 


(2) Store Equipment 


S 800.00 


(3) Borrowed on note 


IOOO.OO 


(4) On Auto 


400.00 


(8) Rental Income 


200.00 


(5) L. & H 


JOOO.OO 


(n) Cash Sales 


800.00 


( 7 ) 'I axes 


140.00 


(13) Interest Income 


IO.OO 


(g) Insurance 


IOO OO 






do) Salaries 


500.00 






(12) Interest Expense 


60.00 



Dr. - 



B. BLACK, CAPITAL 



(i) Cash Investment 



Cr. + 
$5000.00 



6 4 


FUNDAMENTALS OF ACCOUNTING 


Dr. - 


NOTES PAYABLE Cr. -f 






(3) Borrowed on note $1000.00 
(4) Finance notes 600.00 


Dr. + 


STORE EQUIPMENT Cr. 


(2) Purchase 


$800.00 




Dr.+ 


DELIVERY EQUIPMENT Cr. 


(4) Purchase 


$1000.00 




Dr.+ 


LAND AND BUILDING Cr. 


(5) Purchase 


$3000.00 




Dr.+ 


PURCHASES Cr. 


(6) Total 


$1800.00 




Dr.-f 


TAXES Cr. - 


(7) Cash 


$140.00 




Dr.+ 


INSURANCE Cr. 


(9) Cash 


$100.00 




Dr.+ 


SALARIES Cr. 


(10) Cash 


$500.00 





FUNDAMENTALS OF DEBIT AND CREDIT 65 

Dr. + INTEREST EXPENSE Cr. 



(12) Cash 



Dr. - 



$60.00 



MORTGAGE PAYABLE 



Cr.+ 



Dr. - 



(5) On Building $2000.00 



SALES 



Cr.+ 



(u) Total 



$2400.00 



Dr. - 



Dr. - 



RENTAL INCOME 



(8) Cash 



INTEREST INCOME 



Cr.+ 



$200.00 



Cr.-f 



Dr. - 



(13) Cash 



ACCOUNTS PAYABLE 



$10.00 



Cr.+ 



Dr. + 



(6) Purchase on account $1800.00 



ACCOUNTS RECEIVABLE 



Cr. - 



(n) Total on account $1600.00 



The following trial balance taken from the accounts above 
indicates that the entries have been posted correctly, and that 
the ledger is in balance. 



66 FUNDAMENTALS OF ACCOUNTING 



TRIAL BALANCE 

Cash $ 4,010,00 

B. Black, Capital $ 5,000.00 

Notes Payable 1,600.00 

Store Equipment 800.00 

Delivery Equipment 1,000.00 

Land and Buildings 3,000.00 

Purchases 1,800.00 

Taxes 140.00 

Insurance 100.00 

Salaries 500.00 

Interest Expense 60.00 

Mortgage Payable 2,000.00 

Sales 2,400.00 

Rental Income 200.00 

Interest Income 10.00 

Accounts Payable 1,800.00 

Accounts Receivable 1,600.00 

$13,010.00 $13,010.00 



RULES IN SUMMARY FORM 

The rules stated in this chapter are all that is necessary for 
the student to know in analyzing and classifying transactions 
into their proper debits and credits. These rules are now 
stated in their briefest form as follows : 

Assets Liability and Capital 

To increase, debit. To increase, credit. 

To decrease, credit. To decrease, debit. 

Expense Income 

To increase, debit. To increase, credit. 

To decrease, credit. To decrease, debit. 



QUESTIONS ON THE CHAPTER 

1. Define: (a) real accounts ; (b) nominal accounts. 

2. (a) State the rule for debiting and crediting asset accounts. 

(b) State the rule for debiting and crediting liability accounts. 

(c) State the rule for debiting and crediting capital accounts. 

(d) State the rule for debiting and crediting expense accounts. 

(e) State the rule for debiting and crediting income accounts. 

3. State the fundamental rule of double entry bookkeeping. 



FUNDAMENTALS OF DEBIT AND CREDIT 67 

4. Give a transaction involving: 

(a) An increase in an asset and an increase in income. 

(b) An increase in an asset and an increase in a liability. 

(c) A decrease in one asset and an increase in another asset. 

(d) An increase in expense and a decrease in asset. 

(e) An increase in net worth and a decrease in a liability. 

5. What do you understand by the normal balance of an account? 
Explain and illustrate. 

6. What are the normal balances for the five groups of accounts? 

7. Mr. Proprietor borrows $2000.00 in cash from the bank for use 
in his business. 

He admits cash is increased and should be debited, but believes 
his capital account should be increased as an additional investment. 
Do you agree? Why? 

8. (a) What is the reason for showing increases in asset accounts 
on the debit side? 

(b) Could this procedure be entirely reversed? 

(c) Would you approve of reversing the procedure? Why? 

9. Explain the origin of the terms real and nominal. 

10. Can you justify the statement " Expense and Income Accounts 
are only temporary subdivisions of the Proprietor's Capital Ac- 
count "? 



PROBLEM MATERIAL 

PROBLEM i 

Analyze the following selected transactions in the same manner as 
was done in the illustrative exercise ; writing a paragraph showing the 
analysis as an increase or decrease, in asset, liability, net worth, in- 
come or expense account, together with the resulting debit and credit, 

Transaction No. i. 

Mr. Frederick Jones starts business with a cash investment of 

$4200.00. 
Transaction No. 2. 

He pays $100.00 rent for one month. 
Transaction No. j. 

He pays $600.00 cash to the New York Store Supply Co. for fur- 
nishing his store with fixtures. 
Transaction No. 4. 

A purchase of merchandise arrives from the Martin Supply Co. 

billed on 30 days credit $720.00. 
Transaction No. 5. 

He pays $16.00 cash for express on this shipment. 
Transaction No. 6. 

A shipment is received, purchased from the Gordon Co. on 30 days' 
credit $1200.00. 



68 FUNDAMENTALS OF ACCOUNTING 

Transaction No. 7. 

First day's business sold for cash $126.00. 
Transaction No. 8. 

Sold on 30 days' credit $64.00 to Thomas Phillips. 
Transaction No. g. 

Sold on 30 days' credit to H. Boyle $90.00. 
Transaction No. 10. 

Paid $25.00 for an advertisement in the Local News. 
Transaction No. u. 

Gave a $5.00 check to window cleaner for services rendered. 
Transaction No. 12. 

Purchased a new auto truck $1200.00, paid for as follows: gave a 

check $400.00 and a note $800.00. 
Transaction No. 13. 

Another purchase arrived from the Martin Supply Co. $600.00 on 

30 days' credit. 
Transaction No. 14. 

Gave the Martin Supply Co. our check for $720.00. 
Transaction No. 15. 

Received a check from Thomas Phillips $64.00. 

Required: 

1 i ) Analyze the transactions above as directed. 

(2) Post the resulting debits and credits to appropriate ledger ac- 
counts. 

(3) Take a trial balance. 



PROBLEM 2 

Analyze the following selected transactions in paragraph form, as 
was given in the text illustration. 

Transaction No. i. 

Mr. M. Murphy starts business with a cash investment of $3000.00. 
Transaction No. 2. 

He borrows $1000.00 from the Local National Bank, who accepts 

his 60 days' note. 
Transaction No. 3. 

He purchases shelving and store equipment from the Standard 

Equipment Co. on 90 days' credit total $640.00. 
Transaction No. 4. 

He purchases a used cash register for his store paying $40.00 cash. 
Transaction No. 5. 

He purchases merchandise $480.00 from the American Supply Co. 

on 30 days' credit. 
Transaction No. 6. 

He pays $60.00 cash for an advertisement in the Home News. 
Transaction No. 7. 

His cash sales for the day were $210.00. 



FUNDAMENTALS OF DEBIT AND CREDIT 69 

Transaction No. 8. 

He sold to F. Kiley $20.00 on 30 days' credit. 
Transaction No. g. 

He had shelves put in his store, for which he paid $75.00 cash. 
Transaction No. 10. 

Another purchase arrived from the American Supply Co., $520.00 

on 30 days' credit. 
Transaction No. n. 

Sold to J. H. Dunn on account $40.00. 
Transaction No. 12. 

He sends a check $480.00 to the American Supply Co. 
Transaction No. 13. 

He buys a new typewriter $125.00 from the N. B. Typewriter Ex- 
change on 90 days' credit. 
Transaction No. 14. 

He purchases a used office desk for cash $16.00. 
Transaction No. 15. 

Cash sales for the day were $120.00. 
Transaction No. 16. 

Sales on account as follows: J. H. Dunn $60.00; T. Lamb $28.00; 
F. Scott $60.00. 

Required: 

1 i ) Analyze the transactions above as directed. 

(2) Post the analysis to appropriate ledger accounts. 

(3) Take a trial balance. 



CHAPTER VI 
THE GENERAL JOURNAL AND BUSINESS PAPERS 

INTRODUCTION 

The material thus far presented has been of an introductory 
character. One of the chief purposes was to give the beginning 
student a strong foundation upon which he might build the 
work of constructive accounting about to be presented. In this 
chapter we shall study the General Journal, one of the primary 
books of original entry used in double entry bookkeeping. We 
shall also introduce a few business papers and study their use 
in practice. 

THE GENERAL JOURNAL 

In the last chapter a series of transactions was analyzed into 
their debits and credits, and the result of this analysis was re- 
corded directly to the ledger. This was done simply to drive 
home the rules for debiting and crediting. In practice the re- 
sult of each transaction must be recorded in some book of 
original entry before it may be placed in the ledger. In double 
entry this book is known as a journal. 

Historically the modern journal is an outgrowth of the old 
day book used in single entry bookkeeping. This record was a 
veritable history of the business. A complete chronological 
record of every transaction was written into the book so that it 
was very much like a ship's log. 

The modern general journal, as operated in a double entry 
system of records, keeps the same chronological record of each 
transaction, but, as shown in the last chapter, each transaction 
yields a twofold result. This analysis must be recorded for- 
mally in the journal, and the accounts to be debited and credited 
indicated together with an appropriate explanation of the trans- 
action. The explanation may be very brief, or complete details 
may be given, because this record is the first basic recording of 
the transaction; and, if referred to in the future, the explanation 
should recall all details of the entire transaction. 



GENERAL JOURNAL BUSINESS PAPERS 71 



1940 



DEBIT 



CREDIf 



fct, 



ML 



t* 



150 



00 



0. 



na 



tjsr. / 



GENERAL JOURNAL ILLUSTRATED AND EXPLAINED 

The illustration above is from a standard ruled two-column 
general journal. The first two columns on the left are used to 
record the date of the transaction. The next wide space to the 
right is provided for the analysis of the transaction. Here the 
accounts to be debited and credited are written as in the fore- 
going illustration. The next narrow column is used to record 
the folio or number of the ledger pages to which the accounts 
designated are to be posted. In the illustration above the Cash 
account might be ledger account Number i , and a small i should 
be written in the journal folio column. In the folio column of 
the ledger page another i would be written, as the entry comes 
from page i of the journal. The Rent account might occupy 
page 60 or 70 in the ledger, and that page number should be 
written in the journal folio. In the Rent account folio column 
a i would be written because this entry also comes from page i 
of the journal. The importance of the proper use of these little 
columns was mentioned before, but another reminder may be 
helpful. 

The two money columns on the extreme right are provided for 
the debit and credit amounts. The left-hand money column is 
reserved for debits only, while the right-hand column is similarly 
reserved for credits only. Note also, in the illustrations above, 
that the debits are always written on the first line, and the 
credits on the next line below, indented sharply to the right. 
This is a form used since the two-column journal was first intro- 
duced. The amount of space left for indentation depends upon 
the size of the paper used; the important point to observe, how- 
ever, is that the indentation be marked. 

In a compound entry, to be illustrated presently, all the debits 



72 FUNDAMENTALS OF ACCOUNTING 

COMPOUND JOURNAL ENTRY ILLUSTRATED 



1940 



00 



2000 



no 



1200 



on 



mo 



Of) 



JMfi 



M. 



00 



tMSsMsL/ 



are written directly next to the date line, one right under the 
the other, while the credits are each indented the same distance 
and are written directly following the last debit. 

On the next line, after the last credit, an explanation of the 
transaction should be recorded. This explanation will vary in 
length, as was stated above, and only experience will tell how 
much should be written in this space. If the entry were to 
record a sale of a bill of goods to a customer on credit; and an 
invoice were written completely listing each item sold, giving 
credit information and all the details necessary for the transac- 
tion and the invoice is numbered and filed away for safe keep- 
ing; then, if a bookkeeper were simply to write in the invoice 
number, that would be a perfect explanation. Such an invoice, 
a copy of which is always sent to the customer, is documentary 
evidence of the merchandise sent. This form will be presented 
presently. 

It is a very good idea to skip a line between entries; and if a 
heavy line is ruled on the line skipped, then each transaction 
will stand out, and there will be no question as to where one 
entry ends and the next begins. Note also that the entries are 
written in the journal in a strict chronological order. The date 
written in the journal is the date of the transaction and not the 
date entered, because in some busy offices entries will sometimes 
be written into the journals two or three days after the trans- 



GENERAL JOURNAL BUSINESS PAPERS 73 

actions have taken place. Another important observation the 
student should make is that the debits in total must always equal 
the credits in each transaction. This equilibrium started in the 
journal is, of course, maintained in the ledger; and for this rea- 
son the ledger should always be in balance, and a trial balance 
should always have total debits offset by credits of an equal 
amount. This is simply the carrying out of our fundamental 
rule of double entry, that each and every transaction, when 
properly analyzed, must yield equal debits and equal credits. 
In the foregoing illustration four separate debits are listed 
because John Kern is placing four different assets in the busi- 
ness. Each of these assets will, of course, occupy a separate 
page in the ledger, as will the liability account notes payable, 
and John Kern's capital account. Note the completeness of 
this explanation, as compared with the one recording Mr. 
Stone's investment. 



ORIGINATION OF TRANSACTIONS AND PRIMARY DOCUMENTS: 

PURCHASING 

In any business the purchasing of materials or merchandise 
is a most important duty, and quite frequently the work will 
be done by a purchasing agent. This man should be a special- 
ist in buying, and, where a special department is in operation, 
all purchasing will have to follow a definite routine. We shall, 
therefore, first study some of the forms used in purchasing. 

THE PURCHASE REQUISITION 

In a well organized business all purchases originate with a 
purchase requisition. The form of requisition will vary with 
the type of business. It is a written request from one depart- 
ment of the business to the purchasing department, requesting 
it to purchase needed merchandise or supplies. For instance, 
if the office manager wishes to purchase a new desk or type- 
writer, he will fill out a purchase requisition form. This form, 
prepared usually in duplicate, will be a request for the purchas- 
ing agent to purchase. The original requisition goes to the pur- 
chasing department, while a copy remains with the department 
requesting the goods. 



74 FUNDAMENTALS OF ACCOUNTING 



Forta U4-Hm f.1* 

PURCHASING DEFT. 

Pleate ordvr the following goods: 



Remarho 



Ofcfe 



N9 4789 



PURCHASE ORDER ILLUSTRATED 



PNIW 



ORIGINAL PURCHASE ORDER No. 7036 



W.C NICHOLAS, 

Director of Purchase* 
O. W. ACHENBACH. 

Purchasing Agent 



VOID 



L. 



OKUVBMV OATK 



DESCRIPTION AND DELIVERY 



VOID 



VOID 



GENERAL JOURNAL BUSINESS PAPERS 75 



PURCHASE ORDER 

On receipt of the purchase requisition the purchasing depart- 
ment issues a purchase order which will be sent to the company 
from whom the goods are to be obtained. Each form has a good 
reason for its being. The purchase order form may be in use 
for several reasons. A formal written order leaves little doubt 
as to what is wanted, how it is to be shipped, and when it must 
arrive. A number is given which should be used by the shipper 
to identify the shipment on his invoice. The form opposite is 
intended to show how this information may be presented. 

RECEIVING AND CHECKING 

Another important function in the purchasing procedure of a 
well organized business is the proper receiving and checking of 
the merchandise purchased. 

Many business organizations maintain special receiving de- 
partments, where all inward shipments are received. This de- 
partment is supplied with a duplicate of all purchase orders and 
will check incoming goods and invoices against the purchase 

RECEIVING FORMS ILLUSTRATED 



RECEIVING DEPARTMENT 



DATE CONT, 



STOREROOM DEPARTMENT 



7 6 



FUNDAMENTALS OF ACCOUNTING 



orders. They will examine and weigh or count the goods re- 
ceived, and stamp on the invoice which accompanies the ship- 
ment its report on these facts ? noting any defects, shortage, 
or other diversion from what the purchase order calls for. Re- 
ceiving and checking forms are illustrated on page 75. 

THE SALES INVOICE 

This is another very important business form used in every 
business. The bookkeeper or billing clerk lists on this form 
each article ordered by the customer. He usually prepares the 
invoice from the customer's purchase order, or from a sales- 
man's order blank signed by the customer. The Sales Invoice 
is usually prepared in triplicate. One copy goes to the shipping 
department, where the order is filled. The shipping department 
returns the invoice with a notation that each item has been 
shipped; or, if any item is not in stock and cannot be shipped, 



INVOICE ILLUSTRATED 



SURCKAl 



DRE55IMC5 



NCWIftUNSWICXN.*. 



ONDEIt MO. 
REQUISITION NO. 

r 

SOLD 
TO 



MJBMAN NO. 



INVOICM NO. 

mvoicc DATE 



J 



DAT* ft ROUT* 

TERMS! 1 % 10 DAYS. NET 90 DAY* 



MtR'S USE ONLY _ 



NATUBt TITUt 



SEABURY, INC. 



GENERAL JOURNAL BUSINESS PAPERS 77 

then that fact is indicated. The billing department may now 
send a correct invoice to the customer. Most retail stores sim- 
ply use sales " slips " or " tickets " in place of the formal invoice. 
These sales slips help keep track of stock and act as a receipt 
for the customer. If the customer asks to have his purchase 
charged, a more formal invoice will be prepared from the sales 
slip and mailed to the customer. 

The original invoice, as indicated on the preceding page, is 
sent to the purchaser. A copy will be the bookkeeper's author- 
ization to record the sale in the journal, a debit to the customer 
and a credit to sales. The purchaser will use the invoice to 
" check " his purchase order, and will pass it on, if found cor- 
rect, to his bookkeeping department for record and payment. 
On the books of the purchaser this invoice, properly approved, 
will be the authentication for his journal entry debiting pur- 
chases and crediting the company supplying the merchandise. 

BILL 

The term bill is used quite frequently to describe a document 
issued by a person for services rendered. The term is almost 
synonymous with the term invoice, in that it may designate a 
charge for goods as well as services. We speak of a doctor's 
bill, or the electric light bill, or the telephone bill, while the term 
invoice is used more correctly for a sale of merchandise. We 
may ask a wholesale dealer for a bill, but more correct termi- 
nology would be served by use of the term invoice. On the 
other hand, one would not think of asking a doctor to ren- 
der an invoice. A careful use of terminology in accounting is 
a quality which the beginning student should cultivate early in 
his training. 

STATEMENT 

This term refers to a summarized statement of an account 
usually rendered periodically. Many organizations render 
monthly statements. These statements exhibit first the balance 
due at the beginning of the month; to this amount there are 
added the charges for the current month, and, at the same time, 
all payments and allowances, if any, are listed as deductions; 
and finally the statements exhibit the balance due as of the last 
day of the month. 



FUNDAMENTALS OF ACCOUNTING 

STATEMENT ILLUSTRATED 

MONTHLY STATEMENT 

SEflBURYinO 

NEW BRUNSWICK, N. J.. U. S. A. 



L_ 



_j 



AMOUNT ENCLOSED _ 




ALL REMITTANCES TO BE SENT TO MAIN OFFICE. NEW BRUNSWICK, N. J. 

PAYABLi IN NKW YORK FUNDS. 

A statement, as illustrated above, will often be a carbon copy 
of a self-balancing account, as kept by bookkeeping machine in 
the ledger. This statement is available immediately at the end 
of the month, and, by using " window " envelopes, a concern 
can get its statements out promptly with very little effort. 

RECEIPTS 

In order to collect an account in a court of law two important 
points must be proved by the seller. He must prove first the 
goods were ordered, and secondly that the goods were shipped 



GENERAL JOURNAL BUSINESS PAPERS 79 

and that the customer being sued actually received them. The 
first point is easily complied with if a signed order is available, 
while the second link in the chain of evidence calls for a proper 
receipt. If a concern maintains its own delivery system, a re- 
ceipt book should be kept, which will serve as satisfactory evi- 
dence that the goods have been delivered and received by the 
customer. This receipt may be drawn as a very simple form, 
or may take the form of a complete legal document, such as a bill 
of lading, illustrated herewith, used by common carriers. If the 

Uniform Donwtlc Straight BUI of L.dlo* Adopted by Carrier* In Official. Southern end Weetera aeeelflotlon Territories. Mereb II. IMJ. M illtTtl) fcvg I t% 
FORM lt-M-ISM-5 39 Q (PRESCRIBED BY THE INTERSTATE COMMERCE COMMISSION) 

UNIFORM STRAIGHT BILL OF LADING ORIGINAL NOT NEGOTIABLE 

RECEIVED .ub|ct to the daeaUljaUont tod Uiild la effect oo the date of letut of tfati BUI of Udiag, 



at New Brunswick. N J , 



...Company 



the property deacrlbed below, In apparent |nod ""Jfr txcept at noted (content! and condition ol conltntt of packiit* unknown) marked, contftned, and 4etlned tt Indicated below, 

agreed at to eaiii earner of all or any of ai'd property over all'oTany porn,,' oTi^iTroutr"'. '!r' r nt"nand at to each p'arty'ai'any tln'r Interetud In all or any of aalil property, 
that every ier\ice to be performed bertund.tr thall be aubiect lu all the condiuoni m>i piuhihued by U* whetbw printd r wnittn herein r<>naiod includlB| lh condlUoBt OD 
bact hereof which are hereby agreed to by the thipper and accepted fur hira^d! and hi. .tign> ^ 

A Consigned to 
:i nation State of Tounty of 

Route Car Initial Car No. 

Delivering Carrier 



DESCRIPTION OF A 



BANDAGES OR DRESSINGS, DENTISTS'. 
PHYSICIANS' OR SURGEONS' 



The fibre bosei ueed (or (hit thlpment coafonq to (he tproflcetloni 
et forth In the boi makrf t certificate thereon and all other require 
lentt u( Rule 41 ol the Coniolldated Pfetfht ClemiUiUoji 






Minor thall Ufa ibt following 



ThU Shipment it correctly deribed. 
Correct Weight 

lobj*ft to V 

i LINE niuc 
According to 



tvd I 

- apply In prrp*yam>< of tbi 
Kr,M os the poprty dwerlM 



If the htriment mov hi-twrfn two portt by a carrier by water, the law require thai the bill ol lad'ng (hall itate whether It li tarrier t or 
NOTE Wbere the rl It dependent on valu* fhlpperi ir* required lo late prcilinlJy in wriDrig the agreed or declared valu ol the prof 
Tb mv*d or declared v*lu of th. ptop(t7 U hereby tpeclflcally .tt.d by the iblpprr to be not eireedlnt 



Shippers. Per_ 

NEW BRUNSWICK. N J 



-JVgent, Per. 



student is not familiar with this document his local railway 
freight agent will be glad to furnish him with a copy for his 
notes. The importance of keeping all original documents should 
be apparent. 



PURCHASE AND SALES RETURNS AND ALLOWANCES 

Two accounts which should be explained at this time are Pur- 
chase Returns and Sales Returns. Merchandise sometimes will 



8o FUNDAMENTALS OF ACCOUNTING 

not meet the demands of the purchaser, or for some other reason 
will not be acceptable to him; and as the good-will of all cus- 
tomers is to be desired, firms usually will allow such merchan- 
dise to be returned. If the merchandise returned is in good 
order, it may be returned to stock for sale to other customers, 
and the Returned Sales account debited with the sales price of 
such merchandise. In this case there would be nothing lost, 
except handling costs. However, returned merchandise, usually 
having some defects, must be sold (if salable at all) at a con- 
siderable discount. In some instances the damages or defects 
are quite slight and the purchaser may be willing to keep the 
goods if an allowance in price is made. Sometimes a separate 
account is maintained for Sales Allowances, but quite frequently 
a general account termed Sales Returns and Allowances is run 
to handle both returns and allowances. There is no serious ob- 
jection to this practice if the amount of each is relatively small; 
but, where the amounts are considerable, it will be of greater 
service to the management if separate accounts are kept. 

The following journal entries will illustrate the handling of 
(a) sales returns, (b) sales allowances, (c) damages collected 
from express company, and (d} purchase returns. 

(a) Suppose Customer X returns merchandise to us because 
he claims it is not as per sample. 

Sales Returns $20.00 

Customer X $20.00 

To record the receipt of merchandise re- 
turned by Mr. X not per sample. 

(6) Now suppose merchandise shipped to Customer Y is 
damaged in transit and he does keep it, but requests an allow- 
ance, which we grant. 

Sales Allowances $20.00 

Customer Y $20.00 

To record allowance for damages by car- 
rier. 

(c} Suppose the damage to the merchandise above is $15.00 
at cost and the Express Company settles in full. This entry will 
be as follows: 



GENERAL JOURNAL BUSINESS PAPERS 81 

Cash $15.00 

Sales Allowances $15.00 

To record check received from the Ex- 
press Co. for claim on merchandise 
shipped to Y. 

(d) Now suppose $50.00 worth of merchandise purchased 
from the Excelsior Manufacturing Company is imperfect be- 
cause of the manufacturing process, and we return it to them. 
The entry will be: 

Excelsior Mfg. Co $50.00 

Purchase Returns $50.00 

For defective merchandise returned. 

The effect of this transaction is to cut our liability to the 
Excelsior Manufacturing Company $50.00, the value of the 
merchandise returned, and also to set up an account which will 
offset the cost of Purchases. 

The student should realize that purchase returns and sales 
returns are reciprocal accounts on two different sets of books. 
The customer returning merchandise will utilize the Purchase 
Returns account, while the vendor will record the same trans- 
action in his Sales Returns account. 



DEBIT AND CREDIT MEMORANDA 

Many business organizations will have forms printed, as in the 
illustration below, to give recognition to acceptance of returned 
merchandise. These forms vary considerably, but a Credit 
Memo, sent by the vendor to allow for merchandise returned to 
him by the purchaser, usually contains information pertinent to 
the return, such as: Name of the Purchaser, Description of re- 
turned stock, and the Amount allowed. Often these credit 
memos will be numbered for reference. The term credit memo 
is used because it indicates that the customers 7 account has been 
credited on the books of the vendor. This memo, when re- 
ceived by the purchaser, will be utilized as the basis of a journal 
entry such as entry (d) above, while a copy of this same credit 
memo may be the basis of an entry such as (a) above, on the 
books of the vendor. 

A debit memorandum or Debit Memo, as it is called, may be 
issued by either the buyer or seller. The seller may use it to 



82 



FUNDAMENTALS OF ACCOUNTING 



>*M B1.4.10M-12-J7 



SURCKAl 



SEflBURYIRO 



DRESSINGS 



CUCTOMIM NO. 
ACQUISITION MO. 

r 

Credit 
to 

L 



INVOICB NO 
INVOKE OATt 



CREDIT 
MEMORANDUM 



DESCRIPTION 



notify the purchaser of a supplemental charge such as freight 
charges prepaid on behalf of the customer; or possibly to cor- 
rect an invoice for an undercharge. The buyer, on the other 
hand, may use this instrument as a formal notification that 
goods have been returned for some reason, possibly because 
they were damaged in transit as in entry (D) above. In such 
a case the seller may acknowledge receipt of the returned goods 
and his acceptance of the Debit Memo by issuing in turn a 
Credit Memo. 

The form is very similar to the Credit Memo illustrated above 
but is usually printed on a different colored paper. 



CREDIT TERMS AND CASH DISCOUNTS 

When merchandise is sold on credit, some terms of payment 
are made part of the agreement or contract; these terms are 
spoken of as credit terms. Sometimes a bill of goods will be sold 
" net thirty days." These terms indicate that the seller will 



GENERAL JOURNAL BUSINESS PAPERS 83 

allow the purchaser thirty days to pay the bill, but no discount 
is offered for more prompt payment. A very widely used set 
of credit terms is 2/10, 11/30. These terms permit the purchaser 
to deduct two per cent of the total amount if he will pay the bill 
within ten days, otherwise he must pay in thirty days. There 
are other credit terms, such as i/io, n/6o, where the seller offers 
only one per cent for prompt payment; and there are others in 
some lines of business where even three per cent is allowed for 
prompt payment and even longer periods are allowed for a 
smaller discount, such as 3/10, 2/30, n/6o. 

These terms offer three per cent for payment within the first 
ten days, but hold out two per cent for payment in the next 
following twenty days if the purchaser is not in position to avail 
himself of the higher discount. 

These, discounts may amount to a considerable saving be- 
cause, even if an organization has not cash available immedi- 
ately to avail itself of the two per cent discount for prompt pay- 
ment, it will pay that organization to go to its bank and borrow 
the money at six per cent. The two per cent is for payment 
within ten days as against thirty days net, while the bank in- 
terest is six per cent per annum, so that $1000.00 borrowed for 
one year at a cost of $60.00 interest can be turned over twelve 
times and thus bring in cash discounts of $240.00. 



TRADE DISCOUNTS 

Cash discounts are not to be confused with trade discounts, 
which are usually much larger per cents and allowed as mark- 
offs from a wholesale price list to bona fide retailers or members 
of a trade. For instance, a furniture factory may publish a 
catalog with certain fixed prices which are much higher than the 
organization expects to receive from the retailer. A confidential 
price list is then published, mentioning a certain trade discount 
for each item in the catalog. A living room set may be priced 
in the catalog at $500.00, but in the discount list be subject to 
trade discount of 50 per cent. This purchase, when recorded 
on the retailer's book, would be entered as a $250.00 purchase 
and any discounts offered for prompt payment would be based 
on $250.00, the net amount. 



84 FUNDAMENTALS OF ACCOUNTING 

CASH RECEIPTS 

One very important phase of every business is the proper 
handling of cash and cash items. Cash items may be received 
from customers in several forms. Checks without a doubt make 
up the bulk of the receipts received through the mail, while 
currency makes up the bulk of over-the-counter receipts. 
Through the mail, in addition to checks, Postal and Express 
money orders are frequently received, and Western Union and 
Postal Telegraph money orders are also sometimes received. 

In a retail business where the bulk of the receipts is currency 
from over-the-counter sales, control of cash through a good 
central cashier's department or by use of good cash registers is 
usually satisfactory. With a central cashier's department in 
operation, the sales clerks make out sales slips, showing the 
items sold, their unit price, and total amount of the sale. The 
slip also indicates the denomination of the bill presented. The 
sales slip and currency are then sent by automatic conveyor to 
one of the central cashiers, who verifies the calculations, re- 
ceipts the bill and registers the receipt on his register, sending 
back by the same conveyor the receipted sales slip, together 
with change for the customer. A daily check of each clerk's 
slips, and an accumulated total of all clerk's slips, should equal 
the total of the central cashier's tape. 

Receipts through the mail from customers should receive 
equally careful handling. In many organizations a mail teller 
opens all mail from customers and records on a Cash Received 
form all cash received through the mail. The form usually pro- 
vides a space for the customer's name, description of the re- 
mittance, check, money order, etc., with a column for the 
amount. The remittances are fastened to the correspondence 
and placed in a mail basket and, together with the teller's re- 
port, are taken to the cashier who signs for the mail. The 
cashier then enters the receipts on his books, and the total, of 
course, must agree with the total from the mail teller's reports. 
Thus at least two people handle and verify cash received, mak- 
ing what is known in the business and accounting world as an 
internal check. Such an internal check on receipts will go a long 
way toward keeping down embezzlements. 

Another very good rule to insist upon is that every cent of 



GENERAL JOURNAL BUSINESS PAPERS 85 

cash received be deposited daily on the day received, if possible. 
In order that every cent received be deposited, it will be neces- 
sary to maintain change funds and a petty cash fund. A 
change fund is a fixed amount which each cashier or cash regis- 
ter keeps at all times for making change, and is never deposited. 
Some retailers keep fifteen to twenty-five dollars in such a fund, 
which is needed to make change in the morning before the day's 
receipts accumulate sufficiently to take care of change them- 
selves. 

Often, in order to deposit daily, cashiers will be authorized 
to end their business day at 2 130 P.M., when all cash received 
to this time is tabulated and deposited before the bank closes. 
All cash received after 2 130 will be recorded as of the following 
day and go into the next day's cash receipts. 

In mos,t large cities special night depositories are available for 
those who wish to deposit all money received and not risk keep- 
ing it over night. The night deposit facility of many banks con- 
sists of an especially designed metal receiving door which opens 
and forms a semi-circular metal receiving department, and which 
when shut turns, dropping the deposit into a chute leading to a 
safe deposit compartment within the bank. The night deposit 
boxes are usually locked and only those customers who have 
applied for their use are provided with keys. 

CASH DISBURSEMENTS 

Another most important rule which should be established re- 
quires that, as far as possible, all payments be made by check. 
A check endorsed by the party receiving payment is the best 
proof that an item in question has been paid. The use of a good 
voucher check is advised, because a brief statement made part 
of the check will show just what items are being paid by the 
check. Coupled with the voucher is usually a statement that 
acceptance and endorsement of the check constitute payment 
in full of the items listed. 



PETTY CASH 

With a rule in operation that all payments be made by check, 
it will be necessary to maintain a petty cash fund to take care 



86 FUNDAMENTALS OF ACCOUNTING 

of those small items for which it might not be convenient to pay 
by check. 

The best way to handle petty cash disbursements is to estab- 
lish a petty cash fund, which should be placed in the hands of 
some clerk for management. The fund is established by draw- 
ing a check on the general cash fund to the order of Petty Cash, 
for an amount which it is estimated will take care of petty dis- 
bursements for a convenient period such as a week or a month. 
The check should then be cashed by the petty cashier, who will 
have charge of the fund. A second necessary step is to purchase 
Petty Cash Voucher pads from the stationer, similar to the 
form below : 

PETTY CASH VOUCHER ILLUSTRATED 



PETTY CASH VOUCHER 
Date Number 



Received - DOLLARS 

For 



Charged to. 
Approved 



Signed 



Such a voucher should be made out for every petty disburse- 
ment and signed by the person receiving the money. The total 
of all paid vouchers when added to the cash on hand must always 
equal the total of the fund. Periodically the fund must be 
reimbursed by the bookkeeper or the cashier, who will audit the 
petty cash vouchers, classifying them by accounts to be charged 
and draw a reimbursing check for the total. The vouchers are 
his authority for the check drawn and are usually stapled to- 
gether and filed away with a reference to the reimbursing check 
number. 

JOURNAL SUMMARY ILLUSTRATION 

As an aid in further impressing the process of journalizing, 
and that the student may see a journal as a unit, several selected 



GENERAL JOURNAL BUSINESS PAPERS 87 

transactions are now presented and journalized exactly as they 
would be in actual practice. 

Transactions to be Journalized 

(1) A. Johnson wishes to enter the retail hardware business and 
deposits $3000.00 of his personal funds to the credit of his business 
account at the First National Bank. 

(2) He purchases for cash the following items from the Brown 
Hardware Co. which is retiring from business. 

(a) Shelving and store equipment .... $800.00 

(b) A delivery truck valued at 600.00 

(3) He purchases from the Metropolitan Hardware Co., a stock 
of merchandise costing $1640.00, terms 2/10 11/30. 

(4) He purchases a further stock of merchandise from the Tomlin 
Hardware Co., $814.00, terms 2/10 n/3o. 

(5) He pays freight on the shipments above, $76.00. 

(6) Some of the hardware received from the Metropolitan Hard- 
ware Co* is unsatisfactory, and upon his telephoning the company 
they ask him to return it for credit; cost price is $160.00. 

(7) Cash sales for the day $110.00. 

(8) In order to take care of Petty Purchases and payments, Mr. 
Johnson authorizes the establishment of a Petty Cash Fund of $50.00. 

(9) In order to expand his business Mr. Johnson negotiates a 
loan from his bank for $1000.00 and gives his note payable in sixty 
days with interest at six per cent. 

(10) He sells on account hardware to the following accounts: 
T. Jones Building Company, $246.00, terms 2/10 n/3o; and Smith 
Construction Co., $219.50, terms 2/10 11/30. 

( 1 1 ) A credit memorandum arrives from the Metropolitan Hard- 
ware Co. (no entry; see trans. 6). 

(12) He pays the Metropolitan Hardware Co. their account less 
the credit memorandum and the purchase discount. 

( 13) Mr. Johnson gives his check for $75.00 to the Local News for 
an advertisement. 

(14) The Smith Construction Company returns three kegs of nails 
to us for credit, which we billed at $19.50. We allow the return and 
issue a credit memorandum. 

(15) Mr. Smith of the Smith Construction Company gives us his 
check for $196.00 in full settlement of his account. 

In the standard journal form which follows, transaction num- 
bers are used instead of dates, and are written in the center of 
the line rather than in the regular space provided at the left. 
Dating entries in this manner is in accordance with modern 
practice and preferred by many practicing accountants, includ- 
ing the author. When this method of dating is used, the name 
of the month appears only once on the first at the top of a fresh 



88 



FUNDAMENTALS OF ACCOUNTING 



page, all subsequent dates are written simply as a number on 
the line between transactions. 



Cash 



MR. A. JOHNSON GENERAL JOURNAL 

300000 



A. Johnson Capital 
To record A. Johnson's investment in hardware busi- 
ness. Cash deposited to business account in First 
National Bank. 

2 

Store Equipment 
Delivery Truck 

Cash 

Purchased for cash from Brown Hardware Co., retiring 
from business. 

' 3 

Purchases 

Metropolitan Hardware Co. 
Bought on account 2/10 n/3O. 



Purchases 

Tomlin Hardware Co. 
On account 2/10 n/3o 



Freight & Cartage 

Cash 
On Tomlin Hardware Co. shipment 



Metropolitan Hardware Co. 

Purchase Returns 

Mdse. unsatisfactory, returned as per telephoned in- 
structions. 

Cash 

Sales 
Cash Sales for the day. 



Petty Cash Fund 

Cash 
To record establishment of petty cash fund. 



Cash 

Notes Payable 

Mr. Johnson borrows from the First National Bank 
on his 6o-day Note at 6%. 



F. Jones 

Sales 
Terms 2/10 n/3o 

Smith Construction Co. 

Sales 
Terms 2/10 n/3O 



10- 



ii 



80000 
60000 



1640 oo 



814 



7600 



16000 



IOOO 



246 



219 



5000 



3000 oo 



140000 



1 640 oo 



814 



76 



1 60 00 



no oo 



00 



246 



219 



GENERAL JOURNAL BUSINESS PAPERS 89 



-- -' 12 

Metropolitan Hardware Co. 
Cash 
Purchase Discounts 
To record payment of account in full. Total $1,640.00 
less cr. memo 160 $1,480. 




1480 

i 
75 

J 9 

196 
4 


I 

00 
00 

50 

00 

oo 


1450 

-2Q 

75 

iy 
200 


40 

00 

oo 

50 

oo 


*3 
Advertising 

Cash 
Paid to Home News 


14 
Sales Returns 
Smith Construction Co. 
For credit memo on three kegs of nails returned. 


T 5 
Cash 
Sales Discount 
Smith Construction Co. 
Received check in full payment invoice of nth less 
credit memo and 2% discount. 



QUESTIONS ON THE CHAPTER 

1. What do you understand by " a book of original entry "? 

2. Rule a two-column general journal and explain its use in re- 
cording transactions. 

3. (a) Explain the process of posting from the general journal to 
the ledger, (b) What purpose is served by the folio columns in the 
journal and the ledger? Explain fully. 

4. (a) How should a compound entry be written? (b) Explain 
the importance of a clear and adequate explanation for each journal 
entry. 

5. What are some of the advantages to a company employing the 
services of a purchasing agent? 

6. Rule and explain: (a) purchase requisition, (b) purchase 
order. 

7. Explain the use of the sales invoice. 

8. Differentiate between (a) sales invoice and bill, (b) invoice and 
statement, (c) How can an organization facilitate the work of get- 
ting out statements? 

9. Explain the function of a modern receiving department. 

10. Why is a receipt so valuable? 

11. Why is the purchase order also valuable? 

12. What are credit terms? Explain and illustrate fully. 

13. It has been said that it is profitable to borrow money from the 
bank at six per cent in order to accept cash discounts of two per cent. 
Is this true? Would you advocate such a practice? 

14. Explain the creation and the operation of a petty cash fund. 

15. (a) What do you understand by " an internal check "? 
(b) Illustrate with cash receipts. 



9 o FUNDAMENTALS OF ACCOUNTING 



PROBLEM MATERIAL 

PROBLEM i 

Journalize the following selected transactions, post to ledger ac- 
counts, and take a trial balance: 

1. John Price starts business with a cash investment of $3000.00. 

2. He paid his first month's rent of $125.00 to the Realty Co. 

3. He received a shipment of merchandise in amount of $1200.00 

from the Big Town Supply Co., terms net 30 days. 

4. He sells for cash $116.00 on his first day and also on account the 

following customers: D. Bradley $60.00, net 30 days; B. Marks 
$40.00, net 30 days; The Trenton Company $100.00, terms 
2/10 n/30. 

5. He paid the Middlesex Hauling Co. $12.00 on the Big Town ship- 

ment, and $6.00 to deliver the merchandise to the Trenton 
Company. 

6. He establishes a petty cash fund in amount of $100.00. 

7. He purchases a Chevrolet delivery truck total cost $890.00 

for which he gives his check for $490.00 and signs finance notes 
for the balance. 

8. He pays $65.00 cash to N. B. Insurance Co. on the delivery truck 

and $35.00 for a fire policy on his merchandise. 

9. He purchases a new machine for his factory, $720.00 F.O.B. Day- 

ton, Ohio, from the Dayton Machine Co., terms net 30 days. 

10. He pays express charges and hauling on the machine above, 

$30.00. 

11. He pays the N. B. Machine Co. $40.00 to install and test this 

machine. 

PROBLEM 2 

Journalize the following selected transactions, post to ledger ac- 
counts, and take a trial balance: 

1. John Davis starts business with the following investment: Cash 

deposited to his business account $3600.00, Equipment for 
his store valued at $1200.00, and a Delivery Truck valued at 
$600.00. 

2. He rents a suitable store, paying $120.00 for one month. 

3. He purchased $1600.00 worth of merchandise from the Metro- 

politan Supply Co., terms 2/10 n/30. 

4. The Underwood Typewriter Co. sold Mr. Davis a new typewriter 

for $125.00, payable net in 30 days. 

5. He sells merchandise, terms 2/10 n/3O to S. Smithers, total 

$240.00. 

6. Mr. Davis borrowed $1000.00 from the Morton National Bank 

for six months, 6% interest to be paid at maturity. 



GENERAL JOURNAL BUSINESS PAPERS 91 

7. He sells merchandise, terms 2/10 11/30 to T. Dragon, $300.00. 

8. Mr. Davis receives a credit memo of $180.00 for merchandise 

returned to the Metropolitan Supply Co., not as per sample. 

9. He purchased $1800.00 worth of merchandise from City Sales 

Inc., terms 2/10 n/3o. 
10. He received a check $235.20 from S. Smithers in full payment of 

his account, 
n. Cash Sales to date amount to $i 18.00. 

12. Paid salaries in total $125.00. 

13. Mr. Davis arranges with the Metropolitan Supply Co. to accept 

his 30-day 6% note for $1000.00 and a check for $411.60 in 
full settlement of their account to date. 



CHAPTER VII 

NEGOTIABLE INSTRUMENTS AND BUSINESS 
PAPERS (concluded) 

INTRODUCTION 

Transactions involving the use of checks, notes, drafts, and 
acceptances are quite common in modern practice. The busi- 
ness man is glad to accept any of these negotiable instruments 
in settlement of a debt. The check is, of course, the most de- 
sirable and most frequently used instrument of the group. It 
is probably the most important negotiable instrument which 
circulates as cash, and more widely used than any other form of 
negotiable paper. The promissory note is another important 
negotiable instrument which the business man is glad to accept, 
when he cannot have a check. The note, under these circum- 
stances, is particularly desirable for two good reasons. First, a 
note may be discounted at the bank and the proceeds had for 
immediate use. The bank charges a small fee for discounting 
the paper and collecting it at maturity. Another very important 
reason the business man should be glad to have a note, when a 
check is not forthcoming, is the fact that a note is in itself 
written evidence of the existence of a debt and the maker's 
willingness to pay. This latter reason is very important should 
it be necessary to sue the debtor for payment in a court of law. 

The beginning student should have a good knowledge of all 
negotiable instruments, and while the place to study the law of 
negotiable instruments is in a commercial law course, which the 
accounting student should not fail to include in his course of 
study, the author feels that a few essential principles should 
be presented at this time. 

THE UNIFORM NEGOTIABLE INSTRUMENTS LAW 

Today throughout the United States we have a uniform nego- 
tiable instruments law. This law was drawn in order that the 
laws of each state pertaining to negotiable instruments might 
be uniform, and that there should be no longer conflict of laws 
in neighboring states. This act has now been adopted by every 
state in the union. 



NEGOTIABLE INSTRUMENTS 93 

DEFINITION OF NEGOTIABLE INSTRUMENT 

A negotiable instrument is one under which the rights are 
transferred by endorsement and delivery (order paper) or by 
delivery alone (bearer paper), vesting the legal title in the 
transferee. The term negotiable means transferable quality: 
the capacity to pass from one person to another. It is because 
of this quality that negotiable instruments are commonly used 
as a substitute for money. 

NEGOTIABLE INSTRUMENTS DISTINGUISHED FROM OTHER 

CONTRACTS 

A negotiable instrument is a written contract, but it differs 
from ordinary contracts in that its language must conform to 
the strict requirements of the Negotiable Instruments Law; 
also, this Law governs the rights and liabilities of parties to the 
instrument and the method of delivering and transferring it. 

Negotiable instruments, unlike ordinary contracts, are sub- 
jected to special rules the Negotiable Instruments Law 
because of the important use of such instruments in the business 
world as a substitute for money. 

To say that an instrument is non-negotiable does not mean 
that it is invalid. It may be a perfectly good contract, but if 
it is non-negotiable, it will not be governed by the Negotiable 
Instruments Law, nor will the holders of it have the privileges 
and advantages conferred by the act upon holders of negotiable 
instruments. 

PROMISSORY NOTES AND BILLS OF EXCHANGE 

Negotiable instruments are of two types, negotiable notes and 
bills of exchange. Their classification depends upon the par- 
ticular language used and the number of parties necessary for 
the creation of the instrument. 

DEFINITION OF NEGOTIABLE PROMISSORY NOTE 

A negotiable promissory note, as defined by the Uniform 
Negotiable Instruments Act, is " an unconditional promise in 
writing made by one person to another, signed by the maker, 



94 FUNDAMENTALS OF ACCOUNTING 

engaging to pay on demand or at a fixed or determinable future 
time, a sum certain in money to order, or to bearer. " 

DEFINITION OF BILL OF EXCHANGE 

A bill of exchange is an unconditional order in writing, ad- 
dressed by one person to another, signed by the person giving 
it, requiring the person to whom it is addressed to pay on de- 
mand or at a fixed or determinable future time a sum certain in 
money to order or to bearer. 

The parties to a bill of exchange are the drawer, the drawee, 
and the payee. If the drawer accepts the bill, he is known as the 
acceptor. 

Thus, a promissory note is a promise by one person to pay 
another, whereas a bill of exchange is an order by one person 
to another to pay a third person, the payee. However, if a bill 
of exchange is accepted by the drawee, his position is analogous 
to that of the maker of a promissory note. 

Bills of exchange may be classified with respect to the situa- 
tions in which they are used. The bill of exchange in most 
general use is the check. It is an order addressed to the bank- 
drawee by the depositor-drawer to pay the payee the sum indi- 
cated. It is a demand bill of exchange. A bank draft is a 
banker's check; that is, it is a check drawn by one bank on 
another bank, payable on demand. 

SIGHT AND TIME DRAFTS 

Bills of exchange called drafts are also classified as to time. 
Sight drafts are bills of exchange payable at sight. Time drafts 
are drafts payable at a future time, as thirty or sixty days after 
date of acceptance. There are other forms of bills of exchange 
such as the Trade Acceptance, but this instrument is of so much 
importance that it will be defined and illustrated later in the 
chapter. Let us now look at the language and words required 
in all negotiable instruments. 

REQUIREMENTS FOR NEGOTIABLE INSTRUMENTS 

From Section i of the Uniform Negotiable Instruments Law 
we learn that " an instrument to be negotiable must conform to 
the following requirements: 



NEGOTIABLE INSTRUMENTS 95 

1 i ) It must be in writing and signed by the maker or drawer; 

(2) Must contain an unconditional promise or order to pay a sum 
certain in money; 

(3) Must be payable on demand or at a fixed or determinable fu- 
ture time; 

(4) Must be payable to order or bearer; and, 

( 5 ) Where instrument is addressed to drawee, he must be named or 
otherwise indicated therein with reasonable certainty." 

DEFINITION EXPLAINED AND ILLUSTRATED 

(1) Writing and Signature: No particular form of writing 
or signature is required. The writing may be legal if made in 
pencil but for practical reasons banks will not ordinarily accept 
checks written or signed in pencil. 

(2) Promise or Order: To be a negotiable promissory note, an 
instrument must contain a definite promise, and to be a nego- 
tiable* bill of exchange an instrument must similarly contain a 
definite order. However, the word promise or order need not 
be used, provided the language imports a promise or order. 
For example, the words " I will pay " import a promise, but 
the words " I hope to pay " or " I owe you " do not, but simply 
acknowledge indebtedness. The words " I command you to 
pay " import an order, but not " I authorize you to pay," or " I 
request you to pay." Mere words of civility, such as " Please 
Pay " do not impair the force of an order. 

(3) Promise or Order Must Not Be Conditional: Suppose I say 
" I promise to pay X $300.00 if he builds my porch." This 
would not constitute an unconditional promise, because X might 
not build my porch. Performance will not cure the defect be- 
cause the negotiability of an instrument must be judged from 
its face. 

(4) Payable in Money: An instrument to be negotiable must 
be payable in money. An instrument reading, " Thirty days 
after date I promise to deliver 1000 bushels of No. i northern 
wheat," while possibly a very valuable paper, would not be a 
negotiable instrument. However, if I say, " I promise to pay 
$800.00 or 1000 bushels of wheat at the election of the holder," 
such an instrument would be negotiable because such an election 
in favor of the holder promotes negotiability and marketability. 

(5) Sum Must be Certain: If I say, " I promise to pay $30.00 
or $40.00," such an instrument will not be negotiable because 



96 FUNDAMENTALS OF ACCOUNTING 

it is not drawn for a definite sum. A sum is not uncertain, how- 
ever , because it is to be paid (a) with interest; (b) by stated 
installments; (c ) with costs or attorneys 7 fees in case of default. 
Provisions of this sort also aid in the marketability of the in- 
strument. 

(6) Payable on Demand or at a Fixed or Determinable Future 
Date: " Thirty days after you marry my daughter " would not 
be negotiable, because the event might never take place, whereas 
" Thirty days after the death of your grandmother " would be 
satisfactory because death is certain. 

(7) Payable to Order or Bearer: An instrument to be valid 
within the meaning of the act must be drawn either to order 
or to bearer. These are the important words of negotiability, 
and, unless they are present, an instrument otherwise valid may 
not be negotiable. Instruments drawn to " cash " or " payroll " 
or other nonexistent persons have also been held to be ne- 
gotiable. 

OTHER IMPORTANT FACTS REGARDING NEGOTIABLE 
INSTRUMENTS 

The fact that an instrument is not dated does not affect its 
negotiability, nor will the antedating or postdating of the instru- 
ment. The holder of an incomplete instrument has prima-jacie 
authority to insert the date. 

When the sum is expressed in words and figures, the words 
govern. Interest, if provided for, runs from the date of issue if 
no date is stated. The words " value received " are not required, 
but because of custom most printed notes do contain these 
words. These are the most important points to look for if a 
person is unfamiliar with notes. If any of them are missing, the 
business man will do well to refuse the instrument unless com- 
pleted to his entire satisfaction. 

NOTE ILLUSTRATED 



$ 100.00 


New Brunswick, N. J. , Aug. 


1. 19 


Sixty days 


after date !__ promise to pay 




To the Order of 


John H. Brown 
)/100 


nni f A B<5 


Payable at 


The National Bank of N. J. 




Value Received with 


interest at 6% 




No. 46 


Peter Kelly 











NEGOTIABLE INSTRUMENTS 97 

The negotiable promissory note may be drawn in any form 
which conforms to the definition of a negotiable instrument 
just discussed. The form presented is an ordinary stock 
form. 



SOME TERMS USED WITH NOTES 

Maker: The party who makes the note. In the foregoing illus- 
tration, Peter Kelly. 

Payee: The party in whose favor the note is made. John H. 
Brown above. 

Date: The date written on the instrument. In the illustration 
August first. 

Term: The number of days, months or years the instrument has 
to run. In the illustration " sixty days." 
Date of maturity: Date + Term Date of Maturity. In the 
illustration Aug. i + 60 days September 30. 
Face, or Principal Sum: The amount for which the note is drawn. 
$100.00 in the illustration above. 

Rate: The interest rate. In the illustration, six per cent. 
Interest: Principal X Rate X term. In our illustration $100.00 
X .06 X 60/360 = $1.00. 

Maturity Value: Face + interest = maturity value. In the il- 
lustration $100.00 -f- $1.00 = $101.00. 

Date of Discount: The day on which the instrument is dis- 
counted. 

Discount Period: The number of days from the date of discount 
to the maturity date. Suppose, in the illustration above, Mr. 
Brown discounts the note August 13. The discount period 
would be 48 days. 

Discount: The charge made by party discounting, usually a 
bank, at the highest legal rate, which in most states is 6 % . Cal- 
culated on the maturity value of the note. In our illustration: 
$101. oo for 48 days at 6% = $.71. Most banks, however, have 
a minimum charge for such service, some fifty cents, others one 
dollar. 

Proceeds: Maturity value less the discount. In our case 
$IQI.OO $.71 or $100.29, except of course where a minimum 
charge of a greater amount may be in effect. 



98 FUNDAMENTALS OF ACCOUNTING 



ENDORSEMENTS 

A negotiable instrument may be transferred by the holder en- 
dorsing the instrument. This endorsement may take any of 
several forms. 

1. Endorsement in Blank: This is the simplest endorsement 
form. The payee simply writes his name on the back of the 
instrument exactly as it appeared on the face. This will trans- 
fer legal title to the paper to the holder, and legally makes the 
instrument a bearer instrument, and may be negotiated further 
simply by delivery. 

2. Endorsement in Full or Special Endorsement: This endorse- 
ment is to be preferred to the blank endorsement, because it 
designates the new owner's name, as 

Pay to the Order of Henry James 
Peter Kelly 

Such an endorsement makes the instrument payable to the 
person you wish to receive payment and no one else. His en- 
dorsement (which he must make before he can be paid) will 
constitute a good receipt. 

3. Restrictive Endorsement: This endorsement is one which in 
some way restricts further negotiation of the instrument, as 

Pay to the order of 

The National Bank of New Jersey 

for deposit to the account of 

Peter Kelly 

This endorsement is strongly recommended as an endorse- 
ment for all checks to be deposited to the credit of the holder. 
The check or other instrument can then be used only as indi- 
cated in the endorsement, and obviously if lost cannot be fur- 
ther negotiated. 

4. Qualified Endorsement: This endorsement qualifies or limits 
the liability of the endorser, and may be used under certain cir- 
cumstances. The following is a qualified endorsement: 

Pay to the order of 

The National Bank of New Jersey 

without recourse to me 

Peter Kelly, Receiver 



NEGOTIABLE INSTRUMENTS 99 

The trouble with such an endorsement is that the bank would 
not accept it from every holder, because the holder is, in fact, 
trying to release himself from a very important warranty which 
every other endorser gives the warranty of payment to be 
described presently. A qualified endorsement is usual for some- 
one named on the instrument, who is passing title, but is not 
personally benefiting by so doing, as, for example, an executor 
of an estate. Suppose a check comes in for a debt due the estate 
and made payable to Peter Kelly, Executor. Peter Kelly then, 
wishing to deposit the check to the credit of the estate's account, 
would have a right to use the endorsement without recourse. 
All Receivers in Bankruptcy protect themselves from personal 
liability by such an endorsement. But the business man re- 
ceiving full value for the endorsement most certainly cannot 
avail Jiimself of this endorsement. 

ENDORSER'S WARRANTIES 
The qualified endorser above warrants : 

1 i ) The instrument is genuine and in all respects what it purports 
to be on its face. 

( 2 ) That he has good title to it. 

(3 ) That all prior parties had capacity to contract. 

(4) He has no knowledge of any fact impairing the validity of the 
instrument or rendering it valueless. 

A transferor by delivery (but without endorsement) gives the 
same warranties as the qualified endorser. 

In addition to these warranties all unqualified endorsers give 
this most important warranty. They agree that ( i ) if the in- 
strument is duly presented, and (2) dishonored, and (3) if due 
notice of the dishonor is given, then he (the endorser) will pay 
the holder, or any subsequent endorser compelled to pay it. 

This latter warranty, familiarly known as the warranty of 
payment, is of a great deal of importance to the business man. 
As seen above, endorsers for value cannot avoid this warranty. 
It simply means that you guarantee the instrument for its full 
value. But many small business men and other individuals 
often, without fully realizing what they are doing, will give an 
accommodation endorsement to a friend, so that the friend may 
borrow at the bank. In so doing the friend is working on the 



ioo FUNDAMENTALS OF ACCOUNTING 

endorser's credit and the endorser is contingently liable for full 
payment of the instrument if the maker fails to pay. Beginning 
students cannot be warned too early in their business careers 
nor warned too strongly about giving accommodation endorse- 
ments without considerable thought. Just as soon as a person 
signs as accommodation endorser, his name appears on the 
bank's liability ledger; and not only is the accommodation en- 
dorser now contingently liable, but his own credit limit is re- 
duced accordingly. 



CALCULATING INTEREST AND DISCOUNT 

(a) The Time Factor: Interest and discount are expressed in 
terms of an annual rate, but the rate is calculated on the time 
the principal is used. It is therefore important to understand, 
first, how the interest or discount period is calculated. If a note 
is drawn for a period of months, the maturity date falls on the 
same day of the future month. A three-month note dated 
May 15 would mature August 15, and one dated January 31 
for the same period would fall due April 30. If the note is 
drawn for a specified number of days, then the exact number 
of days must be added to the date of the instrument in order to 
find the maturity date. For instance, a note dated February 
10 for thirty days, would fall due March 12. 
(6) Computation of Interest and Discount: Banks and com- 
mercial organizations calculate interest on the basis of a 360- 
day year, rather than the 365-day year used by the government. 
The standard formula for calculating interest or discount is : 
Principal X Rate X Time = Interest. For example, calcu- 
late the interest on a $1000.00 note for sixty days at 6%. 

$1000. X -06 X ~T~ = $10.00 
360 

There are, however, several short-cut methods of obtaining 
the same result. Probably the best and most widely used 
method is the Banker's Sixty-Day Method. This method is 
calculated on the 36o-day year, and since 60 days is one-sixth 
of the year, then at 6% the interest for 60 days is i% of the 
principal. From this fact we observe that to find the interest 
on any sum for 60 days at 6% you simply point off two places 



NEGOTIABLE INSTRUMENTS 101 

to the left of the decimal point in the principal; and similarly 
for 6 days point off three places, because 6 is one-tenth of 60. 
Applying the rule : 

What is the interest on $1000. for 78 days at 6%, 

First break up the number of days into multiples of six, as 

60 days point off 2 places $10.00 

6 days point off 3 places i.oo 

6 days point off 3 places i.oo 

6 days point off 3 places i.oo 

78 days $13.00 

For 42 days on $1000. at 6%. 

30 days point off 2 places and divide by 2 $5oo 

6 days point off 3 places i.oo 

6 days point off 3 places i.oo 

42 days $7.00 

Or, since 42 is exactly 7X6, point off 3 places and multiply by 7 
to obtain the same result. 

For 72 days on $1348.50 at 6%. 

60 days $13485 
6 days 1.3485 

6 clays __i .3485 

72 days $16.1820 or $16.18. 

In order to get the correct result in using this method, observe 
in the case above that rounding off decimals must be postponed 
until the final result is obtained; otherwise, it is possible that 
an inaccuracy of one cent or more may be made; for instance, 
suppose in the case above we rounded off as follows : 

60 days 

6 days 

6 days 
72 days 

ACCOUNTING FOR NOTES 

Receipt of Note from a Customer 

Suppose Mr. Brown buys $500.00 worth of merchandise from 
us pn account, and when payment is due gives us his non- 
interest-bearing promissory note for the amount due. 

The journal entries to express these facts would be as follows : 




102 FUNDAMENTALS OF ACCOUNTING 

April i J. Brown $ 500.00 

Sales $ 500.00 

To record sale, 30 days' credit 



May i Notes Receivable 500.00 

J. Brown 500.00 

To record receipt of Brown's 60- 
day non-interest-bearing note. 

The entry April i records the sale to Brown, resulting in 
Brown becoming one of the accounts receivable of the business. 
May i, instead of paying cash, Brown gives his non-interest- 
bearing note, which is accepted. The second entry records this 
transaction. In the first transaction John Brown owed us 
$500.00 on open account, while after the second transaction he 
owes us $500.00 on a promissory note. The receipt of the prom- 
issory note cancels his liability to us on the book account, and 
is a wise substitution of security which we hold. 

Note Given to Creditor 

The opposite situation is illustrated when we tender our note 
to one of our creditors in payment of our account. 

April i Purchases $1000.00 

N. Y. Wholesale Co $1000.00 

To record purchase on 30 days' 
credit. 



May i N. Y. Wholesale Co 1000.00 

Notes Payable 1000.00 

To record payment of account to 
N. Y. Wholesale Co. with our 60- 
day non-interest-bearing note. 

In this instance we purchased from the N. Y. Wholesale Co., 
on account, and when the bill was due we gave our 6o-day note 
in payment. The April i entry records the purchase and set- 
ting up our liability to the N. Y. Wholesale Co. The May i 
entry illustrates the exchange of liability, from Accounts Pay- 
able to Notes Payable. 

Interest As a Factor 

When interest is added to the face of a note, it becomes to 
the party receiving the note interest earned ; to the party giving 
the note, the addition of interest increases the cost to him, in the 



NEGOTIABLE INSTRUMENTS 103 

form of Interest Expense. The interest is not payable until 
maturity, so it is not a factor altering the journal entry when 
the note is received. The explanation in the journal, however, 
should make note of the interest. When the note is paid or dis- 
counted, however, the interest factor will be reflected in the 
journal entry. 

Interest-bearing Note Paid by Customer at Maturity 

Suppose that Brown's note for 60 days to us did carry six per 
cent interest, and that we held the note to maturity. On June 
30, the note is due, and suppose we receive a check from Brown 
for $505.00. Five hundred dollars is the principal and $5.00 
the interest earned. This transaction would be recorded as fol- 
lows: 

June 30 Cash $ 505.00 

Notes Receivable $ 500.00 

Interest Earned 5.00 

To record payment received on 
Brown's 6o-day note due today. 

Interest-bearing Note Paid to Creditor at Maturity 

On the other hand, let us suppose that the note we gave the 
N. Y. Wholesale Co. was an interest-bearing note. Then the 
following journal entry will result: 

June 30 Notes Payable $1000.00 

Interest Expense 10.00 

Cash $1010.00 

To record payment of our note to 
N. Y. Wholesale Co., plus interest. 

Customer's Non-interest-bearing Note Discounted 

Suppose now that instead of holding Brown's non-interest- 
bearing note we discount it immediately at the bank. The bank 
will pay us $500.00, less the discount of six per cent. This will 
result in the following journal entry: 

May i Cash $ 495-oo 

Interest Expense 5- 

Notes Receivable Discounted . . $ 500.00 

To record the discount of Brown's 
6o-day non-interest-bearing note 
received this day. 



io 4 FUNDAMENTALS OF ACCOUNTING 

When a note is discounted as just illustrated, the business re- 
ceives the face of the note less the discount (usually six per 
cent). The bank holds the note to maturity and collects the 
face amount of $500.00. 

Contingent Liability for Notes Receivable Discounted 

Observe in the last journal entry that, when the note was dis- 
counted at the bank, instead of crediting the Notes Receivable 
Account as might have been done, the credit has been written 
to Notes Receivable Discounted, an altogether different ac- 
count. This account represents a contingent liability which 
should be recorded on the books, because when a note is dis- 
counted the bank requires an endorsement from the party re- 
ceiving the proceeds. The endorser of a note or other negoti- 
able instrument, as was stated before, guarantees payment of 
the note should the maker fail to pay at maturity; and he, the 
endorser, receives due notice of such failure. For this reason 
the contingent liability account should be set up and remain on 
the books until the note is paid by the maker. The endorser will 
be very promptly advised in form of a protest of any failure on 
the part of the maker. 

Cancellation of Contingent Liability When Customer Pays Note 

If twenty-four hours elapse after the due date and no protest 
is received, then the endorser's liability should be canceled as 
is shown by the following entry. 

July 2 Notes Receivable Discounted $ 500.00 

Notes Receivable $ 500.00 

To cancel the contingent liability 
on Brown's 6o-day note due July i. 

Renewing Notes 

When a note matures, it should be paid in full by the maker; 
but often the holder will agree to renew the note or take part 
payment and a new note for the balance. In either case the old 
note should be canceled, and a new note drawn. A journal 
entry such as one of the following will be satisfactory: 

(a) Renewal with cash for interest only. 



NEGOTIABLE INSTRUMENTS 105 

Notes Receivable $ 100.00 

Cash i .00 

Notes Receivable $ 100.00 

Interest Earned i .00 

John Smith gives us his 6o-day 

note and check for $1.00 to take 

up his note due today with interest. 

Renewal with cash for interest and partial payment. 

Notes Receivable $ 75.00 

Cash 26.00 

Notes Receivable $ 100.00 

Interest Earned i .00 

John Smith gives us his 6o-day 

note for $75.00 and his check for 

$26.00 a $25.00 reduction on the 

note and $1.00 interest. 

Dishonored and Protested Notes 

If a negotiable instrument is not paid at maturity, it is said 
to be dishonored, and in order to hold the endorsers it should be 
protested. Protesting a note is usually done by a notary public, 
who makes demand for payment on the maker and, if payment 
is refused, ascertains the reason. He then writes a formal no- 
tice of these facts on a protest form and a copy of this form 
should be sent to every endorser informing them of the dishon- 
ored instrument and that the holder shall look to them for pay- 
ment. If a customer has given you a note and refused to pay 
it at maturity, then his account should be charged with the 
maturity value of the note plus protest charges. 

Suppose John Smith refused payment of his 6o-day, 6% note 
for $100.00 and your bank, acting as your agent, protested the 
note, charging it against your account as follows: Note, $100.00, 
Interest, $i .00, Protest Fees, $2 .40. The following entry should 
be written : 

John Smith $ 103.40 

Cash $ 10340 

To record note of John Smith pro- 
tested today and charged to our ac- 
count at National Bank of N. J. as 
follows: Note, $100.00, Interest, 
$1.00, Protest Fees, $2.40. 



io6 FUNDAMENTALS OF ACCOUNTING 



DISCOUNTING INTEREST-BEARING NOTE 

If Brown's note to us were interest-bearing, a slightly dif- 
ferent result would have to be recorded should we discount 
the note at the bank. The note, being interest-bearing, would 
make it worth at maturity the face plus six per cent, or $505.00. 

The bank discounts a note on its maturity value, therefore 
the bank will take sixty days' discount on $505.00 or $5.05. 
The proceeds would be $499.95 and the transaction recorded as 
follows : 

May i Cash $ 499-95 

Interest Expense .05 

Notes Receivable Discounted . . $ 500.00 

To record the discount of Brown's 
6o-day six per cent note received 
this day, proceeds $499.95. 

It will be apparent that the discount expense is the interest 
cost on the number of days the bank must hold the note to ma- 
turity, deducted from the maturity value of the note. If the 
party receiving a note holds it any part of the term of the note, 
then the discount will be reduced, and as the maturity ap- 
proaches the discount will be offset by the interest earned. This 
would be apparent if the business held the note 30 days and 
then took it to the bank for discount. The bank would pay 
$502.47 for the note and the journal entry would then record 
$2.47 as interest earned as follows: 

May 31 Cash $ 502.47 

Notes Receivable Discounted . . $ 500.00 

Interest Earned 2.47 

To record the discounting of 

Brown's 6o-day note dated May i. 



FURTHER USE OF INTEREST EXPENSE ACCOUNT 

Another use made of the Interest Expense account is to re- 
cord discount when money is borrowed from the bank on the 
proprietor's own personal note. When this is done, the bank 
usually takes out the interest in advance. This is known as dis- 
count and the amount deducted may be charged to the Interest 
Expense account. 



NEGOTIABLE INSTRUMENTS 107 

Cash $1980.00 

Interest Expense 20.00 

Notes Payable $2000.00 

Mr. Brown (proprietor) borrows 
$2000.00, less the bank discount, 
from the National Bank of N. J. 
Note is payable in sixty days. 

FURTHER USE OF INTEREST EARNED ACCOUNT 

Interest received on bank balances, or from investments 
owned, may be credited to this earning account. If the income 
from investments is of considerable amount, then a separate 
account or accounts may be operated, such as Income from In- 
vestments, or Income from Bonds. 

BILLS OF EXCHANGE 

Definition. A bill of exchange is an unconditional order in 
writing, addressed by one person to another, signed by the per- 
son giving it, and requiring the person to whom it is addressed 
to pay on demand or at fixed or determinable future time a sum 
certain in money, to order or bearer. 

Included among bills of exchange are such instruments as 
checks, including cashier's checks, drafts, both sight and time, 
trade acceptances, and banker's acceptances. 

DRAFT ILLUSTRATED 




^L'rmj^iv On-rrhsAs 



n n<n#ji* j*. 



vte&/tte/^m&sfaz^^ 

!. 
pJjsMA, QsniJ* 
Aj ^ 



PARTIES TO A BILL OF EXCHANGE 

1 i ) The Drawer, in foregoing illustration Jones. 

(2 ) The Drawee, in foregoing illustration Cooper. 

(3) The Payee, in foregoing illustration Martin. 



1 08 FUNDAMENTALS OF ACCOUNTING 

If the drawee accepts the bill, he will then be known as the 
Acceptor, and bill will be payable in thirty days after accept- 
ance. A sight draft is " accepted " by giving a check immedi- 
ately. 

NOTE AND BILL OF EXCHANGE DIFFERENTIATED 

A promissory note is a promise by one person to pay another, 
whereas a bill of exchange is an order by one person, the drawer, 
to another, the drawee, to pay a third person, the payee. How- 
ever, if a bill of exchange is accepted by the drawee, his position 
is analogous to that of the maker of a note. The drawee ac- 
cepts a bill of exchange by writing across the face of the bill 
as follows " Accepted, New York, August 3, 19 . Thomas 
Cooper." A check which has been accepted by the drawee bank 
is known as a certified check. 

A sight draft is a draft payable at sight; that is, on present- 
ment to the drawee. 

TRADE ACCEPTANCE 

This is a special form of bill of exchange. It was first intro- 
duced by the Federal Reserve Act in 1914. It may be used for 
current bona fide business transactions only, as we may observe 
from the illustration below where a statement to this effect is 
written on the face of the instrument. For this reason trade 
acceptances are very desirable credit instruments, and ordi- 
narily may be discounted at any National Bank. 

TRADE ACCEPTANCE ILLUSTRATED 



ffij/mtJaffo*, i&fpmaf nif fo 



NEGOTIABLE INSTRUMENTS 109 

Trade acceptances are superior credit instruments and looked 
upon with favor by the bankers because ( i ) they may be issued 
only for a current business transaction, involving the transfer 
of goods from the seller to the buyer; (2) they are therefore 
self-liquidating; (3) they are short-term and not renewable; 
and (4) they are re-discountable by Federal Reserve Banks. 



QUESTIONS ON THE CHAPTER 

1. What is the Uniform Negotiable Instruments Law? 

2. (a) Define a negotiable instrument. 
(b) Explain five parts of the definition. 

3. Name four negotiable instruments. 

4. Define trade acceptance. 

5. List and explain ten terms used with notes. 

6. List and explain four different forms of endorsement. 

7. Which endorsement would you recommend for depositing 
checks? 

8. What do you understand by the endorser's warranty? Ex- 
plain fully. 

9. Explain the function of Interest Expense and Interest Earned 
accounts. 

10. Explain the function of Notes Receivable Discounted account. 
IT. What is Protest? 

12. What disposition should a bookkeeper make of a customer's 
note protested by the bank and charged against your account by the 
bank including interest and protest fees? 

13. Why should the business man be glad to accept a note if his 
customer cannot pay cash when an account is due? 



PROBLEM MATERIAL 

PROBLEM i 

November /, 1940. 

T. Wentworth, who has been in business before, is re-opening and 
asks you to work for him as clerk and bookkeeper. He informs 
you that in addition to $4200.00 with which he is opening a busi- 
ness account he has the following equipment: Auto Truck valued 
at $350.00; Store Equipment valued at $800.00, and some Office 
Equipment, the total value of which is $200.00. Write an open- 
ing entry for this investment and record the following transac- 
tions for the month of November: 



no FUNDAMENTALS OF ACCOUNTING 

November 4. 

Paid one month's rent $125.00. Received Invoices and Shipment 
from Newport Distributors Inc. $1145.00, terms 2/10 n/3o; 
Knight Manufacturing Co. $1760.00, terms 2/10 11/30. The 
goods are checked in and all found to be satisfactory. Purchased 
from MacFarland Importing Co. $820.60, terms 2/10 n/30. 
November 5. 

Mr. Wentworth has shelves and counters built for his store. He 
pays out $294.00 for lumber, $26.00 for hardware and paint, 
and $100.00 for the labor. 
November n. 

Mr. Wentworth purchases a new cash register for his store which 
costs him $300.00 and for which he gives a check for $90.00 and 
signs finance notes for the balance. 
November 12. 

Stationery and other printed business forms arrive $28.00 for 
which a check is drawn. Gave MacFarland Importing Co. 
$804.19 a/c in full. 
November 13. 

He pays $140.00 for an advertisement in the Local News, an- 
nouncing the opening of his store. He pays $12.00 for cleaning 
the store preparatory to opening. Gave Newport Dist. Co. 
$1122.10 account in full. 
November 14. 

The store opens for business and Cash Sales amount to $210.40. 
He pays $36.00 for three tons of coal. He sold to Solomon 
Brothers a total of $240.00, terms 2/10 11/30. 
November 15. 

Cash Sales for the day were in total $110.60. Drew a check for 
$9.00 to be cashed at bank to buy postage stamps. Sold on 
account to K. Williams $414.00, terms 2/10 n/3O. 
November 16. 

A shipment of merchandise arrived from MacFarland Importing 
Co. with invoice for $240.00, terms 2/10 n/3o. Cash Sales for 
the day were $185.00. Sold to B. Fuller $189.00, terms 
2/10 n/30. 
November 18. 

Paid Salaries for the first half of the month total $240.00. Cash 

Sales for the day were $142.75. 
November IQ. 

The Local National Bank has granted Mr. Wentworth a loan, ac- 
cepts his 6o-day note for $1000.00, crediting his account with 
$990.00. Cash Sales for the day were $152.40. 
November 20. 

Received a check from Solomon Brothers for $235.20 full payment 
of invoice of Nov. 14. Cash Sales for the day were $114.00. 
Sold to Solomon Brothers $320.00, terms 2/10 n/3o. 



NEGOTIABLE INSTRUMENTS 



in 



November 21. 

Gave our 6o-day note for $1760.00 to the Knight Mfg. Co. Sold to 
B. MacDonald $410.00, terms 2/10 11/30. Cash Sales tor the 
day were $98.00. 

November 22. 

Received an invoice and shipment from the Newport Distributors 
total $1326.40, terms 2/10 11/30. Sold to K. Williams $229.00, 
terms 2/10 11/30. Sold on same terms to B. Fuller $214.00. 
Received an invoice and shipment from the Knight Mfg. Co. 
total $1320.80, terms 2/10 11/30. The Cash Sales for the day 
were $78.00. 

November 25. 

Received a check $405.72 from K. Williams full settlement invoice 
of Nov. 15. Received an invoice and shipment from the Mac- 
Farland Importing Co. total $415.00, terms 2/10 n/3O. Cash 
Sales for the day were $112.40. 

November 26. 

Received a check $185.22 from B. Fuller full payment invoice of 
Nov. 16. Cash Sales for the day were $98.75. 

November 27. 

Sold to Solomon Brothers $190.00, terms 2/10 11/30. Cash Sales 
for the day were $110.15. Purchases three new filing cabinets 
for the office $180.00 from the Globe Office Equipment Co. terms 
30 days net. Gave a check $122.40 to Local News for our ad- 
vertisements to date. 

November 28. 

Received a check from B. MacDonald $410.80 full settlement 
invoice of Nov. 21. We accept a $320.00 6o-day 6% note from 
Solomon Brothers dated Nov. 28. The note is immediately dis- 
counted at the local bank and our account is credited with the 
proceeds. The Cash Sales for the day were $119.40. 

November 29. 

Sold to B. Fuller $326.00, terms 2/10 n/3o and to B. MacDonald 
$820.00 on the same credit terms. The Cash Sales for the day 
were $124.60. Paid Salaries to date $240.00. 

Required: 

1 i ) Journal entries. 

( 2 ) Post to ledger accounts. 

(3 ) Trial balance of the ledger. 

PROBLEM 2 

November i. 

J. B. Wells purchases the following assets from Mr. T. Sanders, 
with which he intends to start business. Land and Buildings 
at depreciated values $4500.00 and against which there is a 
$2500.00 mortgage which Mr. Wells assumes; there are two 
trucks, one almost new valued at $1500.00 and another old truck 



ii2 FUNDAMENTALS OF ACCOUNTING 

valued at $300.00; office equipment at depreciated values 
$600.00. Mr. Wells engages you to operate a simple two-column 
general journal and a standard double entry ledger. He in- 
structs you to set up the assets acquired, and the liability as- 
sumed, crediting him with his net capital investment. He also in- 
forms you that as of this date he has deposited $2100.00 to his 
business account with the City National Bank. 

November 2. 

Mr. Wells instructs you to pay the current tax bill in amount of 
$200.00. A shipment of goods together with an invoice arrives 
from the General Wholesale Co. $1800.00; terms are 2/10 n/30. 

November 4. 

Mr. Wells purchases a new truck from the Grand Auto Company, 
for $i 500.00 ; they accept the old truck at its book value $300.00, 
a check for $700.00 and finance notes for the balance. 

November 5. 

Mr. Wells purchases two spare tires at wholesale from a friend, pay- 
ing $40.00 cash; they are for the new truck just acquired. 
Mr. Wells has John Arnold insure his trucks against fire, theft, 
and public liability, for which Arnold bills Wells $80.00 to be 
paid within 30 days. 

November 6. 

Mr. Wells signs for a new machine which has just arrived from the 
Troy Machine Co.; the accompanying invoice is $310.00, terms 
2/15 n/3o. Mr. Wells authorizes you to draw a check for 
$42.00 express charges on this machine. A shipment of mer- 
chandise and invoice arrive from Thomas Brothers Inc. total 
$1400.00, terms 2/10 n/3O. 

November 7. 

A shipment of merchandise and invoice arrive from Shultz Dis- 
tributors Inc., total $1150.00, terms 2/10 11/30. Mr. Wells sells 
to Thomas Slater $510.00, terms 2/10 n/3o. 

November 8. 

Mr. Wells sold to Alex Kohl $240.00, terms 2/10 11/30, and to 
Henry Martin on the same terms $375.00. 

November p. 

Some of the merchandise received from the Shultz Distributors Inc. 
was damaged and returned, for which you have received a credit 
memo $50.00. Gave a check for $50.00 to finance company to 
pay the first payment on the new truck. 

November-ii. 

Alex Kohl asks Mr. Wells if he will accept a 6o-day non-interest- 
bearing note for $240.00 in payment of his account. Mr. 
Wells agrees and a note is drawn, dated November n. Mr. 
Wells instructs you to take the Kohl note to the bank for dis- 
count. He endorses it and the bank credits his account with the 
proceeds. 



NEGOTIABLE INSTRUMENTS 113 

November 12. 

Mr. Wells asks you to d^aw a check for $180.00 to the Home News 
Inc., your advertising for the week. Mr. Wells had arranged 
with the National Bank to discount his 6o-day note for $1800.00; 
the bank informs you that they have granted the loan and cred- 
ited Mr. Wells' account with the proceeds. 

The General Wholesale Company asks Mr. Wells if he will help 
them out by giving them a note for the $1800.00 he owes them, 
so that they may get funds immediately from their bank. Mr. 
Wells agrees and issues a 6o-day non-interest-bearing note for 
$1800.00. 

November 13. 

A check for $367.50 arrives from Henry Martin marked full 
payment invoice Nov. 8. A shipment of merchandise arrives 
with an invoice from the General Wholesale Co. $410.00, terms 
2/10 n/30. Mr. Wells instructs you to pay Thomas Brothers 
their account in full less any discount due him. 

November 14. 

Sales were made on the usual terms to Thomas Slater $404.00, and 
Alex Kohl $305.00. Received two new filing cabinets for the 
office, together with a $75.00 invoice from the General Whole- 
sale Co., terms 2/10 11/30. 

November 15. 

A check for $499.80 arrived in the morning's mail full payment of 
Nov. 7 invoice to Thomas Slater. A check is drawn to the 
Standard Service Station for gas and oil used in trucks to date 
$40.00. 

November 16. 

Our bank returns Thomas Slater's check $499.80 marked in- 
sufficient funds, together with a protest fee of $2.60, and notify- 
ing that they have charged our account $502.40. A check for 
$200.00 is drawn to pay salaries to date. A check for $575.00 
is drawn to the Bankers Trust Co. who hold the mortgage; the 
check represents $75.00, the semi-annual interest and a $500.00 
reduction of the principal. Mr. Wells calls Mr. Slater on the 
phone regarding the protested check, and Mr. Slater promises 
to replace it with a certified check for the full amount. 

November 18. 

The morning mail brings a certified check for $502.40 from Mr. 
Slater. Sold $225.00 to Henry Martin on the usual terms. 

November ip. 

We accept merchandise returned from Alex Kohl as not perfect and 
issue a credit memo to him for $15.00; at the same time we sell 
Mr. Kohl a further order totaling $416.00 on the usual terms. 

November 20. 

A check for $90.00 is drawn for our advertisements in the Daily 
Home News to date. Mr. Wells asks that a check for $200.00 



ii 4 FUNDAMENTALS OF ACCOUNTING 

be drawn to his order for his personal use. (Open a drawing ac- 
count for Mr. Wells.) 

November 21. 

A shipment and invoice arrive from the Thomas Brothers $710.00, 
terms 2/10 n/30. A check for $303.80 is drawn to the order of 
the Troy Machine Co. payment in full of our account to date. 

November 22. 

Mr. Wells instructs you to pay John Arnold his insurance bill in full 
$80.00. Mr. Wells made a special sale for cash $72.00 and turned 
over the money to you for deposit. 

November 25. 

A check arrived $284.20 from Alex Kohl payment of Nov. 14 
invoice less the credit memo and proper discount. Mr. Wells 
gives you a personal check for $1000.00 to deposit to his business 
account as an additional investment. 

November 26. 

A new machine arrives by express from the Troy Machine Co.; 
the invoice price is $645.00, terms 2/10 n/3o, but a check in 
amount of $55.00 is given to the Railway Express for charges on 
the machine. Sold to Henry Martin usual terms $406.00. 

November 28. 

Mr. Wells pays the Troy Machine Co. representative $60.00 for 
erecting and testing the new machine as per agreement. We give 
our 30-day b% note to the Shultz Distributors for $1100.00. 

November 29. 

Mr. Wells' application for a bank loan has been approved, and the 
bank discounts Mr. Wells' note of 90 days for $2000.00, credit- 
ing his account with the proceeds. This loan was made to help 
out the General Wholesale Co. who are in financial difficulties 
and have offered Mr. Wells to surrender the $1800.00 note they 
held for $1700.00 spot cash. Mr. Wells takes up the note on 
their terms, advising you to credit the gain to Interest Earned. 

November jo. 

Four checks are drawn as follows: To the Home News Inc. for ad- 
vertising $90.00; to the Standard Service Station for gas and 
oil used in truck to date $51.00, and to Universal Garage for 
repairs on truck $16.00, and for $260.00 salaries to date, 

Required: 

1 i ) Journal entries 

( 2 ) Post to ledger accounts 

(3 ) Trial balance of the ledger 



CHAPTER VIII 
SPECIAL JOURNALS 

INTRODUCTION 

The general journal studied in Chapter VI would work quite 
satisfactorily in a business where the number of entries were 
few each day, but where the number of transactions are numer- 
ous the introduction of special journals becomes almost impera- 
tive. Special journals may be designed to accommodate many 
special situations. The principal special journals, and those 
found most frequently in practice, are the Purchase Journal, the 
Sales Journal, the Cash Disbursements book and the Cash Re- 
ceipts book. The General Journal is still retained in such a sys- 
tem, but to handle only those transactions which cannot fit in 
the special journals, such as transactions with notes received 
from customers or notes given to creditors, purchase returns 
and allowances, and sales returns and allowances. Quite often 
two special journals will be merged, as in the voucher system, 
where the Purchase Journal and Cash Disbursements book may 
be combined. Accountants today will devise special journals 
to fit individual businesses and it is remarkable what efficient 
systems may be devised when a real specialist sets to work in- 
stalling a special system. The guiding maxim used by account- 
ants and one which should be kept in mind by anyone who 
designs a system, is that it shall give " the maximum of infor- 
mation with the minimum of effort." 

The present chapter will confine itself primarily to a study 
of the Purchase Journal, the Sales Journal, and the two Cash 
Journals, together with the General Journal as used with these 
special journals. 

THE PURCHASE JOURNAL 

The Purchase Journal, as its name indicates, is designed to 
handle all purchases of merchandise. Before the book itself is 
presented, the evolution and need for it will be briefly reviewed. 

Suppose the following five purchases are written into a two- 
column General Journal as explained in the last chapter. 



n6 



FUNDAMENTALS OF ACCOUNTING 



DEMONSTRATION EXERCISE 

1. Purchase on account from N. Y. Wholesale Co. $600.00. 

2. Purchase on account from Excelsior Mfg. Co. $800.00. 

3. Purchase on account from Trenton Co. $1200.00. 

4. Purchase on account from Excelsior Mfg. Co. $400.00. 

5. Purchase on account from N. Y. Wholesale Co. $1000.00. 

Leaving out explanations , these entries would be recorded as 
follows : 

-i- 

Purchases $ 600.00 

N. Y. Wholesale Co $ 600.00 



Purchases 

Excelsior Mfg. Co. 



-2- 



800.00 



800.00 



Purchases 

Trenton Company 



Purchases 

Excelsior Mfg. Co. 



Purchases 

N. Y. Wholesale Co. 



-4- 



-5- 



1 200 .00 



400.00 



1000.00 



I2OO.OO 



400.00 



1000.00 



If the journal entries just completed are studied, one point 
should stand out. The account, Purchases, is repeated five 
times and would be repeated as many times as there were pur- 
chases during the month. 

The inefficiency of such procedure will be evident when the 
numbers of purchases are many. The same five transactions 
are now written into a special Purchase Journal. 



PURCHASE JOURNAL 



Date 


Account Credit 


Terms 


Order No. 


F 


Amount 


Sept. 


i 

2 

3 
4 
5 


N. Y. Wholesale Co. 
Excelsior Mfg. Co. 
Trenton Company 
Excelsior Mfg. Co. 
N. Y. Wholesale Co. 
Total Purchases 


2/10 n/3o 
2/10 n/30 
Net 30 da. 
2/10 n/30 
2/10 n/30 
for month debi 


1375 
1376 
1377 
1378 
1379 
i 




600 
800 
1 200 
400 

IOOO 


oo 

00 

oo 

00 
00 


4000 


oo 



SPECIAL JOURNALS 117 

In the General Journal five postings would have to be made to 
the Purchases account, and if 500 purchases were made, the 
Purchases account would be cluttered up with a great deal of 
useless detail. By the use of a special journal only one posting 
in total to the Purchases account is required. This would be 
true regardless of the number of purchases, and will offset the 
individual credits made to the various creditors' accounts. The 
management ordinarily wishes to know total purchases for the 
month or other accounting period, and this may be had from 
the Purchases account in the ledger. If any detail is desired 
regarding individual purchases, this can readily be had from 
the Purchase Journal. This is easier than the general journal 
method, for in the Purchase Journal only purchases are kept, 
whereas in the general journal all types of transactions are writ- 
ten in chronological order, with no attempt to classify. In 
both books individual posting to the various creditor accounts 
is necessary, and when the special journal is used this posting 
is done from day to day. 

At the end of the accounting period only one posting to the 
Purchases account is required. This will complement all the 
individual credits and keep the ledger in balance. 



SALES JOURNAL 

Demonstration Exercise 

i. Sold on Account $100.00 to S. Jacobs. 
2 . Sold on Account $60.00 to A. Frank. 

3. Sold on Account $40.00 to L. Bond. 

4. Sold on Account $80.00 to M. Tracey. 

5. Sold on Account $120.00 to J. Fisher. 

Omitting explanation and terms which we shall suppose are 
all alike, 2/10, n/3o, these transactions would appear in the 
general journal as follows: 



-i- 



S. Jacobs ........................ $100.00 

Sales .......................... $100.00 



A. Frank ........................ 60.00 

Sales .......................... 60.00 



FUNDAMENTALS OF ACCOUNTING 



-3- 

L. Bond $40.00 

Sales $40.00 



-4- 



M. Tracey 
Sales . . . 



80.00 



-5- 



J. Fisher 120.00 

Sales 



80.00 



120.00 



If we again note the journal just completed, we shall see, as 
with the purchases illustration, the account Sales is written five 
times, and if there were five hundred sales the account Sales 
would be repeated that many times. The inefficiency here is 
the same as that illustrated with Purchases. The same sales 
transactions are now written into a sales journal. 

SALES JOURNAL 



Date 


Account Debit 


Invoice No. 


F 


Amount 


Sept. 


i 

2 

3 
4 
5 


S. Jacobs 
A. Frank 
L. Bond 
W. Tracey 
J. Fisher 
Total Sales for Month ( 


Ki37 
Ki 3 8 

Ki 3 9 
Ki4O 
KHI 
Credit 




IOO 

60 
40 
80 
1 20 


oo 
oo 
oo 
oo 

00 

oo 


400 



In the general journal five separate postings are required to 
the sales account, while but one posting to the sales account is 
necessary when the special sales journal is used. The Sales ac- 
count in the general ledger would contain only summary infor- 
mation rather than the great bulk of detail, which would result 
if the two-column general journal were used. 

Of course, detail posting to the individual customer's accounts 
is required as before. The saving of time, space, and effort re- 
sults from the single posting at the end of the period to the 
Sales account, instead of two or three thousand separate post- 
ings which would be necessary if the general journal were used. 
The economy of the special form journals is so obvious that to- 
day it is the exception not to find special journals in use. 

It will be noticed that the form of the Sales book is very simi- 
lar to that of the Purchase book, the only difference being the 



SPECIAL JOURNALS 119 

posting, which is just the reverse of that in the Sales book. The 
books may, of course, be expanded in form, and more detail 
regarding the items purchased or sold could be provided for. 
However, inasmuch as a reference is made to the primary rec- 
ords, the purchase order, and sales invoice, it is ordinarily un- 
necessary to give any further detail. 



THE CASH RECEIPTS JOURNAL 

As purchases and sales are kept in special journals, so also 
are cash received and cash paid out kept in separate books. 

In presenting the Cash Receipts journal we shall omit any 
demonstration exercise, presuming that by this time the student 
can readily recognize the economy and superiority of special 
journals. 

CASH RECEIPTS JOURNAL 



Date 


Acct. Credit 


Explanation 




Total 
Cr. 


Disct. on 
Sales Dr. 


Net Amt. 
Reed. Dr. 


Sept. 


j 


B. Brown, capital 


Investment 


v 7 


3000 


oo 






3000 


oo 




8 


S. Jacobs 


Pd. in full 






















less 2% 




IOO 


oo 


2 


00 


98 


oo 







Rental Income 


Reed, rent 






















from 2d il. 




80 


00 






80 


oo 




10 


M. Tracey 


Ck. in full 






















less 2% 




80 


oo 


I 


60 


78 


40 




ii 


B. Brown, capital 


Additional 






















invest. 




IOOO 


oo 






IOOO 


oo 




12 


L. Bond 


Pd. in full 






















less 2% 




40 


00 




80 


39 


20 




17 


J. Fisher 


Pd. in full 






















net 




1 20 


oo 






1 20 


oo 












4420 


oo 


4 


40 


44i5 


60 


(vO ( ) ( ) 



The transactions illustrated above are clear enough from the 
explanations given. The first entry will result in a credit to 
B. Brown Capital account. In the second entry S. Jacobs' ac- 
count will be credited with $100.00, the amount in Total col- 
umn. Mr. Jacobs paid us his account in full by remitting 
$98.00. The difference amounting to $2 .00 is the sales discount, 
which we allow for prompt payment. The Total column is 
used for the amount to be posted to the account responsible for 
the remittance. In the illustration, Brown's Capital account, 



120 



FUNDAMENTALS OF ACCOUNTING 



S. Jacobs' account, Rental Income, M. Tracey, B. Brown Capi- 
tal, Bond, and Fisher, will be credited individually with the To- 
tal amounts next to their names. The Discount on Sales column 
is posted only in total at the end of the month or other account- 
ing period. Likewise, the Net Cash column is used only as a 
summary column with one posting at the end of the month to 
the debit of Cash. 

Under the column Total is entered a check mark ( \/ ) to in- 
dicate that the items have been posted individually and do not 
require posting in total. Under the Discount on Sales column 
we usually write the number of the page in the ledger to which 
the total amount is posted; and in the same manner the page 
to which the Net Cash Received is posted is written under that 
column. 

The equilibrium fundamental to double entry bookkeeping 
is established by the two summary debits, Cash $4415.60, and 
Discount on Sales $4.40, being equaled by individual credits, 
amounting in total to $4420.00. 



CASH DISBURSEMENTS BOOK 
CASH DISBURSEMENTS 



Date 


Acct. Debit 


Explanation 


F 


Total 
Dr. 


Disct. on 
Purch. Cr. 


Net Cash 
Payt. Cr. 


Sept. 


4 


N. Y. Whlse. Co. 


Pd. in full less 






















2% 




600 


00 


12 


oo 


588 


OO 




10 


Taxes 


Pd. -J yearly tax 




240 


00 






240 


oo 




12 


Excelsior Mfg. Co. 


Pd. inv. of 2 less 






















disc. 




800 


00 


16 


oo 


784 


oo 




15 


Stationery 


Bought for cash 




16 


00 






16 


00 




20 


Trenton Co. 


a/c in full less 






















disc. 




1 200 


oo 


24 


oo 


1176 


oo 




28 


Insurance 


Pd. for Fire Prot. 




60 


oo 






60 


oo 




3 


Salaries 


Pd. Office Salaries 




1 20 


00 






120 


00 












3036 


oo 


52 


oo 


2984 


00 



(v/) '( ) ( ) 

In this book the individual accounts are posted from day to 
day; the various creditors' accounts and expense accounts be- 
ing debited with the amounts in the Total column. The Dis- 
count on Purchases column is posted in total at the end of the 
month to the credit of the Purchase Discount account. In the 



SPECIAL JOURNALS 121 

illustration above the equilibrium is again maintained. A total 
debit to various individual accounts in amount of $3036.00 is 
offset by two credits: Discount on Purchases $52.00 and Cash 
$2984.00, both posted in total. 

Sometimes the two cash books are bound in one. The left- 
hand page is reserved for Cash Receipts, while the right-hand 
is for Cash Disbursements. There are several reasons why this 
is not a good custom, although in a small business it is not ob- 
jectionable. 

Where the two books are bound in one, it is possible to por- 
tray the contrast between cash receipts and cash payments, and 
at the close of the accounting period to display the balance of 
cash. 

In the average business Cash Receipts will require a great 
many more lines to record than will Cash Payments, because 
the receipts will be received in many small amounts, while pay- 
ments for the most part will be made in larger amounts. This 
will result in the left-hand page being used, while the right-hand 
page is only half used. This waste of space is not the principal 
reason favoring the separate binding of the books. The fact 
that separate cash receipts and cash payments book permit a 
subdivision of labor is probably the chief reason for keeping 
the books apart. 

CASH BALANCE ILLUSTRATED 

In the illustration, page 122, the Cash Receipts, including 
the proprietor's original investment, were $4415.60, while cash 
in amount of $2984.00 was paid out, leaving $1431.60 as the 
cash balance. This balance should be the balance of the Cash 
account in the general ledger. 

At the start of the new month the Cash Balance may be, and 
often is, written in at the top of the Net Cash column in the cash 
receipts book, to which is added all cash received and the column 
footed daily so that the bookkeeper or the cashier may know 
at any time the balance of cash available for payments. If this 
is done, then at the close of the period the opening balance must 
be deducted from the total or Net Cash Received column, to 
arrive at the current amount received, which should then be 
posted to the debit of the cash account. This should be obvious 



122 



FUNDAMENTALS OF ACCOUNTING 



when we remember that the cash account in the general ledger 
reflected the cash balance at the beginning of the period; there- 
fore, the only amount we should post is current cash receipts. 

The handling of the Cash Balance is illustrated in the follow- 
ing abbreviated form: 



CASH RECEIPTS 



DATE 



ACCOUNT CREDIT 



ITEMS 



TOTAL 
CR. 



SALES 

DISCOUNT 

DR. 



NET 

RECEIVED 
DR. 



QtL 



LTJtlL 



Jz. 



-33bL 



ML 



_$. 



ML 



ML 



60 



00 



00 



qonn 



00 



THE GENERAL JOURNAL 

Even when these four special journals are in use, there is 
still a function to be performed by the general journal. It must 
be used for those transactions which cannot be fitted into some 
of the special journals. 

For example, if the company receives a note from a customer, 
the entry must go in the general journal, because the entry can- 
not be classed as a purchase or sale, nor has it anything to do 
with cash receivable or payments. When the customer pays the 
note at maturity, the cash receipts book will be utilized because 
then cash will be received. Similarly, should an organization 
give its note in payment of an account the general journal must 
be similarly used. Again also, when the note matures and is 
paid in cash, the cash disbursements book will be used to record 
the cash payment. 

The general journal is used for all adjusting and closing en- 
tries. This work is reserved, however, for a future chapter and 
will be explained at that time. 

Opening entries are usually written into the general journal in 
complete form, even though part of the entry may also be 
written in one or more special journals. 



V 


3000 
8000 


00 
00 








2OOO 


OO 








2000 


00 












5000 


OO 








JOOOO 


OO 



SPECIAL JOURNALS 123 

The following entry will illustrate: 

Cash 

Land & Buildings 
Merchandise Inventory 
Auto Truck 

Mortgage Payable 

J. Brown, Capital 

To record Investment of Mr. Brown in the 
Printing Business. 

ENTRIES IN TWO JOURNALS AND CROSS-CHECKING 

Often it will be desirable to enter certain items in two books, 
as in the journal entry above. The cash part of the investment 
may also be placed in the cash receipts book because in truth 
it is also a cash receipt. To prevent double posting under such 
circumstances it becomes necessary to cross-check the appro- 
priate accounts in both journals. 

In the general journal entry above it will be noted that Cash 
is checked, which means that the $3000.00, although written 
to the debit of Cash, is not to be posted from the journal. When 
it is so checked the amount is also written in the cash receipts 
book to the credit of Brown Capital account and there also in 
the folio column must be entered another check. This second 
check will prevent double posting of the credit to the proprie- 
tor's capital account. The double recording is made so that 
each journal will show all entries which pertain to it. 

CASH SALES IN BOTH CASH RECEIPTS AND SALES BOOK 

Cash Sales represents a receipt of cash and at the same time 
a sale. It is, therefore, desirable to record the facts in two 
journals. 

Illustration. Suppose a cash sale of $100.00 is made. The 
cash received would be entered in the cash receipts book as 
follows : 

CASH RECEIPTS BOOK 



Date 


Account Credit 


Explanation 


F 


Total 
Cr. 


Sales 
Disct. Dr. 


Net Cash 
Dr. 


19 




















Nov. 


Sales 


Cash Sale 


V 


IOO 


00 






IOO 


OO 



124 FUNDAMENTALS OF ACCOUNTING 

and in the sales journal as follows: 

SALES JOURNAL 



Date 


Account Debit 


Invoice No. 


F 


Amount 


19 












Nov. 


Cash 


Cash Sale 


V 


IOO 


00 



In this manner the cash sale is entered in two books. The sales 
book will show sales from all sources, and the cash receipts book 
will exhibit cash received from all sources including sales. The 
cross-checking will prevent double posting, which must be 
guarded against. 

OTHER SPECIAL JOURNALS 

i. Purchase Returns Journal. If returned purchases are few 
in number, then the general journal will be utilized; but, like 
all other transactions, just as soon as they become numerous, 
it will pay the bookkeeper to install a special journal. 
A form such as the following might be used: 

PURCHASE RETURNS JOURNAL 



Date 


Account Debit 


Explanation 


F 


Amount 


19 
Nov. 


Excelsior Mfg. Co. 

Thompson Brothers, 
Inc. 


Returned not as sam- 
ple 
Returned damaged 




140 

20 


CO 

oo 



A book such as this would be handled just as the Purchases 
book, except, of course, that the accounts would now be debited, 
to show a reduction in the original amount credited in the pur- 
chase record. The form may be drafted to take care of any 
special information desired. 

2. Sales Returns Journal. Similarly, a special journal may be 
established to take care of sales returns and allowances any 
time such transactions are of sufficient frequency to warrant it. 
In general, the form would be similar to the purchase returns 
journal, just illustrated. The account heading would, of course, 
be credited, so that the customer would be given credit for any 



SPECIAL JOURNALS 125 

merchandise returned. When special journals are operated for 
purchase and sales returns, only one posting is made at the end 
of the month to the Purchase Returns and Sales Returns ac- 
counts for the total. Individual postings must be made daily. 

3. Notes Receivable Journal. If an organization does a con- 
siderable amount of business with notes, then it may find it will 
save time and give better display to the notes if a special notes 
receivable register is maintained. 

Several interesting forms have been devised to record notes 
received. The usual information desired is : ( i ) Date Received, 
( 2 ) From Whom Received ( Account to be credited ) , ( 3 ) Date 
of Note, (4) Amount of Note, (5) Term, (6) Rate of Interest, 
(7) Endorsers if any, (8) Date of Maturity. 

In designing such a book the information could be set in sep- 
arate columns as indicated above with a folio column inserted 
between columns 3 and 4. The date of maturity (8) above may 
occupy a whole page and be spread out into twelve columns, one 
for each month of the year. In this way the maturity dates may 
be easily watched. 

In the same manner a Notes Payable Register may be in- 
stalled if the number of notes given is numerous enough to war- 
rant it. 

4. Other Special Journals. Other special journals may be de- 
signed to meet almost any situation. For example, a real estate 
organization might hold a great many mortgages and it would 
be desirable to have a Mortgage Receivable Register designed 
for it. System building is one of the valuable services ren- 
dered by the certified public accountant; however, we shall not 
trespass further in this elementary text. For our work we shall 
confine out attention to the first four special journals presented, 
namely, the Purchase Book, Sales Book, Cash Receipts, and 
Cash Payments Book, and the General Journal which we shall 
continue for all those transactions which we cannot fit into one 
of the four special journals. 



126 FUNDAMENTALS OF ACCOUNTING 



QUESTIONS ON THE CHAPTER 

1. Explain how special journals operate to save time, space, and 
effort. 

2. Are there any other advantages in the use of special journals? 

3. Rule and describe the form and illustrate with typical entries: 
(a) Purchase Book; (b) Sales Book; (c) Cash Receipts Book; 
(d) Cash Payments Book. 

4. Explain the method of summary posting for each of the four 
special journals required above. 

5. What do you understand by cross-checking? 

6. Illustrate how cash sales may be recorded in both the Cash 
Receipts and the Sales Books. 

7. Explain and illustrate how the cash balance may be written in 
the Cash Receipts Book. 

8. Would you advocate combining the Cash Receipts and Cash 
Payments Books into one? Why? 

9. Enumerate the advantages of special journals. 

10. Explain how each of the following books should be posted: 
(a) daily, (b) monthly. Tell also how the ledger is kept in balance 
in each case. 

(1) Purchase Book 

( 2 ) Sales Book 

(3) Cash Receipts Book 

(4) Cash Disbursements Book 

11. What is the function of the general journal when special jour- 
nals are in use? 



PROBLEM MATERIAL 

PROBLEM i 
February 3, 19 . 

E. Wilson has just started in the general merchandise business; 
he purchased the following assets from K. Tyler who is retiring 
from business. Store Equipment, valued at $1000.00; Office 
Equipment valued at $400.00; and an inventory of Merchandise 
costing $3000.00 which is less than current market value. Mr. 
Wilson asks you to operate a simple set of books consisting of 
a Purchase book, a Sales book, a Cash Receipts Book, a Cash 
Disbursements Book, and a General Journal as illustrated in 
Chapter VIII. He informs you that, in addition to the invest- 
ment above, he has deposited $2500.00 to his business account in 
the Citizens' National Bank. You are to record the foregoing 
investments in the proper journals and enter the following 
selected transactions for the month of February: 



SPECIAL JOURNALS 127 

February 4. 

A shipment of merchandise arrived with invoice from Fredericks 
Manufacturing Co. total $810.40, terms 2/10 11/30. Paid rent 
$250.00. 
February 5. 

Mr. Wilson purchased new equipment for the store from the N. Y. 
Store Supply Co. for $260.00 terms net 30; sold on account to 
F. Aborn merchandise for $240.00, terms 2/10 n/3O. 
February 8. 

A new typewriter was bought for the office for $125.00; purchased 
from Appleton Inc. merchandise which was received with an in- 
voice for the amount of $396.20, terms 3/10 n/3o. 
February p. 

Cash Sales to date $113.00; sold G. Blume merchandise on account 

total $360.00, terms 2/10 n/3o. 
February 10. 

Paid salaries for week $120.00. 
February n. 

Purchased stationery forms for office amounting to $17.60. 
February 12. 

Invoice and shipment received and checked from Murphy Sales 

Inc. for $320.90, terms i/io n/3O. 
February zj. 

Sold to H. Crone merchandise for $185.00, terms 2/10 n/3O. Re- 
ceived check from F. Aborn for invoice of Feb. 5 less 2%. 
February 15. 

On this day Mr. Wilson discounted his 6o-day note of $1000.00 at 
the Citizens' National Bank discount rate 6%\ sold to J. Davis 
on account merchandise for $220.00, terms 2/10 n/3o. 
February 16. 

Purchased from Gordon Hosiery Mills merchandise which was re- 
ceived today with an invoice amounting to $174.80 terms net 
30 days. The merchandise was checked and found to be in con- 
formity with invoice. Sold to F. Aborn merchandise for $375.00, 
terms 2/10 11/30. 
February 17. 

Check was received from G. Blume for invoice of Feb. 9 less 2%. 
Paid to Appleton Inc. invoice of Feb. 8 less 3%; paid salaries 
for week $120.00. 
February 18. 

F. Aborn returned merchandise claimed unsatisfactory, and we 
issued a credit memo for $45.00. Sold merchandise to G. Blume 
for $290.00, terms 2/10 11/30. We paid the Fredericks Mfg. Co. 
their invoice of Feb. 4 in full. They accept our 6o-day 6% note 
for $500.00 and our check for $304.19 allowing us the 2% dis- 
; count, although the discount period is past. 
February 79. 

Cash Sales to date were $210.00. 



128 FUNDAMENTALS OF ACCOUNTING 

February 21. 

Received shipment and invoice from Fredericks Mfg. Co. for mer- 
chandise purchased $640.00, terms 2/10 n/3o; sold to J. Davis 
on account $275.00, terms 2/10 n/3o; received check from 
H. Crone for invoice of Feb. 13 less discount. Bought postage 
stamps for $12.00 cash. 
February 22. 

Sent our check to Murphy Sales Inc. for invoice of Feb. 12 less dis- 
count ; we returned merchandise to Gordon Hosiery Mills which 
we found to be imperfect, and for which we received a $26.00 
credit memo. 
February 23. 

Received check from J. Davis for invoice of Feb. 15 less discount. 
February 24. 

Received check from F. Aborn for invoice of Feb. 16 less credit 

memo and discount. 
February 25. 

Received merchandise from Murphy Sales Inc. today with invoice 
for $284.50, terms i/io n/3o; sold to F. Aborn on account 
$110.00, terms 2/10 n/3o; paid salaries for the week $120.00. 
February 27. 

G. Blume purchased merchandise for the amount of $230.00, terms 

2/10 n/30. 
February 28. 

Bought Land and Building for $5000.00 and as per agreement paid 
by check $2000.00 for down payment and gave mortgage for 
$3000.00; received goods and invoice from Apple ton Inc. for the 
amount of $553.80, terms 3/10 n/3o; cash sales to date were 
$146.00. 

Required: 

1 i ) Enter the transactions above as directed. 

( 2 ) Total and post all special journals. 

(3 ) Trial balance of the general ledger. 

PROBLEM 2 

J. MacDonald Johnstone decides to enter the importing business 
and engages a suitable office and storage warehouse. You are to 
act as his bookkeeper, operating a set of books as outlined in 
Chapter VIII, consisting of four special journals and a general 
journal. Mr. Johnstone is an importer of Scottish woolens and 
specialties, and plans to sell to wholesale dealers. The following 
are his transactions for the month of May: 
May i, 19 . 

Mr. Johnstone opened a checking account with the Broadway Trust 
Co. depositing $7200.00 to his business account. He pays 
$300.00 for rent to N. Y. Realty Co. He contracts with Mr. 
G. Losee to construct storage shelves and cabinets in the ware- 



SPECIAL JOURNALS 129 

house for an agreed sum of $300.00 to be paid within 30 days, 
exclusive of lumber and hardware which Mr. Johnstone is to 
pay for separately. He pays out $240.00 to the Martin Lum- 
ber Mill for required lumber and $46.00 to the Thompson Hard- 
ware Co. for hardware and paints. 
May 2. 

The International Business Machines Co. furnish his office at a 
total cost of $220.00 paid in cash. Purchased from MacDonald 
Import Co. $1265.40, terms 2/10 n/3o. 
May 4. 

Purchased from MacPherson Inc. $720.80 terms 2/10 n/3o; he 

paid for one month's rent advertising $245.00. 
May 5. 

We returned to MacDonald Import Co. certain imperfect materials 

and issued a debit memo for $60.20. 
May 6. 

Sold to J. Kirkland $610.72, terms 2/10 11/30. 
May 7\ 

Purchased from MacLeod Mfg. Co. $1860.00, terms 3/10 n/30. 
May8. 

We received some merchandise returned from J. Kirkland as not 

satisfactory and issued a credit memo for $20.42. 
May 10. 

Paid MacDonald Import Co. the balance of invoice May 2 less dis- 
count. Purchased from MacTavish Mills $1470.00, terms 3/10 
n/30. Sold to A. Clyde and Co. $284.20, terms 2/10 n/3o. 
May n. 

We return some damaged goods to MacTavish Mills $20.00 and 

issued a debit memo. 
May 12. 

Paid MacPherson Inc. invoice May 4 less discount. 
May 14. 

Purchased from MacDonald Import Co. $1190.70, terms 2/10 

n/3o; sold to MacNab and Cohn $824.00, terms 2/10 11/30. 
May 15. 

A. Clyde and Co. ask for an allowance for damages to shipment 
which we allow for $22.50. Sold to D. Fraser Ltd. $1200.00, 
terms 3/10 11/30. Paid salaries to date $320.00; paid George 
Losee his account in full. Received a check from J. Kirkland 
for $578.49 full payment of invoice May 6 less credit memo and 
discount. 
May 1 6. 

Gave MacLeod Mfg. Co. our check for $1804.20 full payment of 

invoice of May 7. 
May 17. 

Purchased from MacPherson Inc. $692.80, terms 2/10 n/3o; sold 
to MacNab and Cohn $426.00, terms 2/10 11/30. Received a 



I 3 o FUNDAMENTALS OF ACCOUNTING 

check from A. Clyde for $256.47 full payment of May 10 in- 
voice less the credit memo and discount. 
May 18. 

Gave MacTavish Mills our check $1406.50 full payment invoice 

of May 10. 
May 20. 

Received a shipment and invoice from the MacLeod Mfg. Co. total 
$2400.00, terms 3/10 n/30. Sold to J. Kirkland $206.80, terms 
2/10 n/30. We accept a 6o-day 6% note from D. Fraser Ltd. 
dated May 20 as payment of invoice of May 15. Gave the 
American Express Co. our check $64.00 express charges to date. 
We discount the Fraser note at our bank and receive credit for 
the net proceeds. 
May 21. 

We received a check for MacNab and Cohn full payment of May 14 

invoice. 
May 22. 

Sold to D. Fraser Ltd. $1340.00, terms 3/10 11/30. The MacLeod 
Mfg. Co. agree to accept our 6o-day 6% note for $2400.00 as full 
payment of invoice of May 20. Purchased MacTavish Mills, 
$1300.00, terms 3/10 11/30. 
May 24. 

The bank has approved our 6o-day note for $1200.00, crediting 
our account with the proceeds. We send MacPherson Inc. our 
check for $678.94, full payment invoice May 17. Sold to Clyde 
and Co. $417.28, terms 2/10 n/30. 
May 26. 

Received a check for $417.48 from MacNab and Cohn full pay- 
ment of May 17 invoice. 
May 27. 

Sold to J. Kirkland $714.00, terms 2/10 n/3o; purchased from 

MacLeod Mfg. Co. $750.00, terms 3/10 n/3o. 
May 28. 

Sold to D. Fraser Ltd. 3/10 n/30 total $620.00. Received from 
the American Express Co. $22.50 a full settlement of our claim 
for allowance made to A. Clyde and Co. May 15. Sent Mac- 
Tavish Mills our check for $1261.00 as full payment invoice 
May 22. Sold to MacNab and Cohn $910.50, terms 2/10 n/30. 
Purchased MacPherson Inc., $820.30, 2/10 n/30. 
May 31. 

Paid salaries to date by check $320.00; sold to A. Clyde and Co. 
$472.50 terms 2/10 11/30. 

Required: 

1 i ) Enter the transactions above as directed. 

( 2 ) Total and post all special journals. 

(3) Trial balance of the general ledger. 



CHAPTER IX 

SUBDIVISION OF THE LEDGER AND 
CONTROLLING ACCOUNTS 

In the last chapter special journals were presented. One of 
the advantages of using special journals is that a subdivision of 
labor is made possible. In such a case, where more than one 
bookkeeper is working with the books of original entry, it will 
be necessary to have more than one ledger, because obviously 
two bookkeepers could not post to one ledger at the same time. 
Therefore, in any system of books, when it becomes necessary 
to expand the general journal it also becomes necessary to ex- 
pand the general ledger. 

The most appropriate division is to separate the accounts into 
three general groups and form three ledgers. The first group 
of accounts removed from the general ledger are the customers' 
accounts which are placed in a new binder to form the Accounts 
Receivable Ledger. Similarly, all creditors' accounts are re- 
moved from the general ledger and placed in another new binder 
to form the Accounts Payable Ledger. 

The two newly formed ledgers are known as subsidiary 
ledgers, because the general ledger containing the remaining ac- 
counts must continue to be the principal book of final entry. It 
is therefore necessary that controlling accounts be established 
in the general ledger to maintain complete control over all ac- 
counts of the business. 

FORMATION OF ACCOUNTS RECEIVABLE LEDGER 

The modern loose-leaf system makes the actual separation of 
the books quite a simple matter. It is only necessary to pur- 
chase two new binders similar to the general ledger, and remove 
all customers' accounts to one of the new binders. With this 
done, it is then necessary to place a controlling account in the 
general ledger to represent the accounts removed. 

Illustration. Suppose the trial balance on the following page 
is taken from the ledger of the Holland Wholesale Grocery 
Company. 



132 



FUNDAMENTALS OF ACCOUNTING 



TRIAL BALANCE 



Cash $ 16,430.00 

Land and Buildings 40,000.00 

Inventory of Groceries 132,800.00 

Storeroom Fixtures 52,600.00 

Delivery Equipment 50,000.00 

Customer i 1,400.00 

Customer 2 1,600.00 

Customer 3 3,200.00 

Customer 4 1,800.00 

Customer 5 1,200.00 

Customer 6 to 240 (detail amounts 

omitted to conserve space) 228,000.00 

Notes Receivable 36,000.00 

Notes Payable $ 60,500.00 

Mortgage Payable 25,000.00 

W. Holland Capital 1 13,160.00 

Taxes 1,600.00 

Insurance 2,400.00 

Heat & Light 240.00 

Purchases 292,000.00 

Interest Cost & Discounts 6,240.00 

Interest Income & Discounts 4,800.00 

Sales 472,000.00 

Newark Grocery Co 17,500.00 

Wilburt Supply Co 8,950.00 

Chieftain Products Corporation 24,720.00 

General Distributing Co., Inc 16,880.00 

Creditors 5 to 96, inclusive 124,000.00 

$867,510.00 $867,510.00 

In the trial balance illustrated, note that there are 240 cus- 
tomers' accounts, although detail amounts for only five are 
given. The remaining accounts are summarized to save space 
in listing. In actual practice, however, the length of this trial 
balance and the size of the ledger can well be imagined, for the 
240 customers' accounts are not a great many for a wholesale 
grocery company; perhaps 2400 would be more nearly correct. 
The principle involved, however, is the same. 

The bookkeeper will first remove the 240 customers' accounts 
from the old loose-leaf binder and place them in a new one. 
This done, he must then open the Accounts Receivable Con- 
trolling Account in the general ledger to take the place of the 
accounts just removed. 



CONTROLLING ACCOUNTS 



133 



ACCOUNTS RECEIVABLE CONTROLLING ACCOUNT 

Defined. A Controlling Account is an account kept in the 
general ledger to control a group of similar accounts kept in a 
subsidiary ledger. The balance of a controlling account should 
equal the total of all individual account balances kept in the 
subsidiary ledger, which it controls. 

The Accounts Receivable Controlling Account, also known 
as the customers 7 controlling account, controls all the customers' 
or accounts receivable accounts. 

ESTABLISHMENT OF ACCOUNTS RECEIVABLE 
LEDGER AND CONTROLLING ACCOUNT 

If the general ledger and the new subsidiary ledger are similar 
loose-leaf books, then it will be necessary for the bookkeeper 
only to transfer the individual customers 7 accounts to the new 
binder and open in their place a single controlling account. It 
may be desirable to make formal note of this transfer, in which 
case a memorandum or proforma entry might be written in the 
general journal, indicating the status of the several individual 
accounts transferred. This may consist of a brief statement 
together with a typed list of the accounts transferred and their 
balances, the total of which would be equal to the debit balance 
in the controlling account substituted in their stead. 



ACCOUNTS RECEIVABLE CONTROLLING ACCOUNT 
ILLUSTRATED 

ACCOUNTS RECEIVABLE CONTROLLING ACCOUNT 



(1) Debit with total of balance of 
all customers' accounts transferred. 
(When the account is first estab- 
lished.) 

(2) Debit at the end of each account- 
ing period with total credit sales from 
the Sales Journal. 



(3) Credit at the end of the account- 
ing period with all cash received from 
customers from a special column in 
the Cash Receipts Journal. 

(4) Credit at the end of the account- 
ing period, with total of all notes re- 
ceived from customers and allowances 
made for sales returns. This amount 
will come from a special column in 
the new General Journal. 



The balance of this account will be on the debit side and 
represent the total due from customers and be exactly equal to 



i 3 4 FUNDAMENTALS OF ACCOUNTING 

the total of all customers' account balances in the Accounts Re- 
ceivable Ledger. 

ACCOUNTS PAYABLE CONTROLLING ACCOUNT 

This controlling account must be opened in the general ledger 
to take the place of all the individual creditors' accounts which 
are to be placed in a new subsidiary ledger. 

ESTABLISHMENT OF ACCOUNTS PAYABLE LEDGER AND 
CONTROLLING ACCOUNT 

The following journal entry will act as authority for the trans- 
fer of all the accounts payable accounts, from the general ledger 
to the subsidiary accounts payable ledger, and will at the same 
time establish the Accounts Payable Controlling Account in the 
general ledger to take the place of the individual accounts 
transferred. 

GENERAL JOURNAL 

Newark Grocery Co $ 17,500.00 

Wilburt Supply Co 8,950.00 

Chieftain Products Corporation 24,720.00 

General Distributing Co., Inc 16,880.00 

Creditors 5 to 96 124,000.00 

Accounts Payable Controlling Account $192,050.00 

To record the transfer of 96 creditors' 
accounts from the General Ledger to the 
new Accounts Payable Ledger. (As the 
binders are loose-leaf the accounts are 
simply transferred, and in their place is 
opened a controlling account.) 

This entry is similar to one which might have been written 
when establishing the Accounts Receivable Ledger and would 
be all that is necessary to establish the new subsidiary ledger 
and appropriate controlling account. 

This formal entry may be omitted and only a memorandum 
noting the transfer written in the journal. 



CONTROLLING ACCOUNTS 



135 



ACCOUNTS PAYABLE CONTROLLING ACCOUNT 
ILLUSTRATED 

ACCOUNTS PAYABLE CONTROLLING ACCOUNT 



(1) Credit with total of balances of 
all creditors' accounts transferred 
(when account is first established). 

(2) Credit at the end of each account- 
ing period with total purchases from 
the Purchases Journal. 



(3) Debit at the end of each account- 
ing period, with all cash paid to credi- 
tors from a special column in the Cash 
Disbursements Book. 

(4) Debit at the end of each account- 
ing period with total of all notes given 
to creditors and allowances for mer- 
chandise returned to creditors. This 
amount will come from special col- 
umn in the new General Journal. 



The balance will be on the credit side and will represent the 
total due to creditors, and should be exactly equal to the total of 
all creditors' balances in the accounts payable ledger. 



JOURNALS RE-DESIGNED FOR CONTROLLING ACCOUNTS 
SALES JOURNAL 

When controlling accounts are in use, the simplest form of 
Sales Journal will be a three-money-column book, one column 
for the Sales on Account } one for Cash Sales, and a third for 
Total Sales. 

SALES BOOK 



Date 


Account Debit 


Invoice No. 


F 


Sales on 
Account Dr. 


Cash 
Sales Dr. 


Total 
Sales Cr. 


Nov. 


i 


Customer One 


1420 




3>5oo 


oo 






3,5oo 


00 




i 


Cash 


Cash Sales 






















for week 


V 






230 


00 


230 


00 




2 


Customer Two 


1421 




3,400 


oo 






3,400 


oo 




3 


Customer Three 


1422 




1,900 


oo 






1,900 


oo 




4 


Customer Four 


1423 




3,900 


00 






3,900 


oo 




5 


Customer Five 


1424 




2,800 


oo 






2,800 


oo 




8 


Cash 


Cash Sales 






















for week 


v/ 






340 


00 


340 


oo 












i5,5oo 


00 


570 


oo 


16,070 


00 



(V) 



POSTING INSTRUCTIONS 



From day to day post to Customers' Accounts in the accounts 
receivable ledger a debit for each sale made as recorded in 



136 



FUNDAMENTALS OF ACCOUNTING 



Sales on Account column. The total of this column must be 
posted to the Accounts Receivable Controlling Account at the 
end of the month. The cash debits for cash sales are checked, 
indicating that these are not to be posted from this journal. 
They are, however, as explained before, posted from the cash 
book as cash receipts. The Total Sales column must be posted 
in total at the end of the accounting period to the credit of Sales. 



CASH RECEIPTS JOURNAL WITH CONTROLLING ACCOUNTS 
CASH RECEIPTS 











Cr 


Pr 


Cr. 


Dr. 


Dr. 


Date 


Account Credit 


Explanation 


F 


Gen. 
Ledger 


Cash 
Sales 


Accts. 
Rec. 
Cont. 


Disct. 
on 
Sales 


Net 
Cash 
Rec'd. 


Nov. 


i 


Sales 


C.S. for week 


V 






230 


00 










230 


OO 




3 


Customer One 


Acct. less 2% 












1 900 


OO 


38 


oo 


1862 


00 




5 


Customer Two 


Acct. less 2% 












I2OO 


oo 


24 


oo 


1176 


00 




7 


Customer Three 


Acct. less 2% 












3200 


00 


64 


00 


3136 


oo 




o 


Customer Four 


Acct. less 2% 












900 


00 


18 


00 


882 


oo 




ii 


Customer Five 


Acct. less 2% 












800 


00 


16 


00 


784 


oo 




15 


Sales 


C.S. for week 


V 






340 


00 










340 


oo 




20 


Notes Pavable 


Borrowed from 






























Bank 




1000 


00 














1000 


00 




2,5 


T. Holland, 


Additional 




























Capital 


Investment 




500 


oo 














500 


00 












1500 


oo 


570 


oo 


8000 


oo 


1 60 


oo 


9910 


oo 



(v/) (vO () 



() 



POSTING INSTRUCTIONS 

The General Ledger column is reserved for miscellaneous 
items to be posted daily to the respective accounts in the gen- 
eral ledger. The Cash Sales are checked, because the sales credit 
was made from the sales book, and this signal is to prevent an 
inexperienced bookkeeper from making a double posting. 

The third money column is reserved for cash credits to cus- 
tomers remitting. In the foregoing example each customer will 
be credited in the accounts receivable ledger with the gross 
amount appearing in the third column. The Discount on Sales 
column should be posted in total at the end of the period to the 
debit of the discount on sales account in the general ledger. 
The last column Net Cash Received will be posted only in total, 
once at the end of the accounting period to the debit of the Cash 
account. 



CONTROLLING ACCOUNTS 



137 



GENERAL JOURNAL NEW FORM 

Just as soon as subsidiary ledgers and controlling accounts 
are established, it will be necessary to adopt a new form of gen- 
eral journal. The six-column general journal illustrated below 
is a form quite frequently used in practice to make posting to 
controlling accounts more convenient. 

GENERAL JOURNAL 



Accts. 
Payable 
Dr. 


Accts. 
Rec. 
Dr. 


General 
Ledger 
Dr. 


F 


Entry 


F 


General 
Ledger 
Cr. 


Accts. 
Rec. 
Cr. 


Accts. 
Payable 
Cr. 


5000 
650 


oo 
oo 


60 
~6o 


00 
00 


300 
2500 

i Bo 


oo 

00 
00 








60 

5000 
650 


00 

oo 
oo 


300 
2500 


00 
00 

oo 


180 


oo 


Sales Returns 
Customer Four 
To record merchandise re- 
turned by customer four 


Notes Receivable 
Customer Four 
To record receipt of a 60- 
day 6% note from customer 
four. 


3 
Office Equipment 
N.Y. Office Supply Co. 
To record purchase of new 
desk. 


4 
Customer Fifteen 
Sales 
To correct invoice #1535- 
item omitted. 


5 
General Distributing Co. 
Notes Payable 
We gave 6o-day note 6% to 
Gen. Distributing Co. 
A 


Wilburt Supply Co. 
Purchase Rets. 
We returned merchandise 
as not satisfactory. 


2980 
60 

5650 


oo 

00 
00 


V 


Accts. Rec. Control 
Accts. Payable Control 


V 


57io 
2800 

1 80 


oo 
oo 

00 

oo 


2800 


5650 


00 










1 80 


00 






8600 


oo 


8690 







POSTING INSTRUCTIONS 



Perhaps the best way to explain posting this new six-column 
general journal will be to explain briefly each of the six selected 



138 FUNDAMENTALS OF ACCOUNTING 

transactions. The first transaction records the usual sales re- 
turn; the Sales Returns account is kept in the general ledger 
and therefore recorded in the General Ledger column. The 
credit to Customer Four is entered in a special column reserved 
for credits to customers. In the second transaction Notes Re- 
ceivable is debited in the General Ledger column, while the 
credit is entered in the special column for Accounts Receivable. 
The third entry illustrates the purchase of an asset, which must 
be entered in this book as a debit to Office Equipment in the 
General Ledger, and a credit to the N. Y. Office Supply Co. in 
the special column provided for credits to Accounts Payable. 
The fourth entry is a correction entry, and utilizes the special 
column for Accounts Receivable debits, the credit to sales is en- 
tered in the General Ledger column. The fifth entry debits the 
General Distributing Company through the special column pro- 
vided for Accounts Payable debits; the credit to Notes Payable 
is entered in the General Ledger column because the Notes Pay- 
able account is a General Ledger account. The sixth entry 
records a purchase return made to one of our creditors. The 
Purchase Returns account is in the General Ledger where the 
credit is entered, while the corresponding debit is entered in 
the special column reserved for Accounts Payable debits. 

SUMMARY POSTING OF GENERAL JOURNAL 

At the end of the accounting period all six columns are totaled. 
The totals of the Accounts Receivable and Accounts Payable 
ledger columns are then brought over and entered in the Gen- 
eral Ledger columns debit and credit, respectively. These totals 
are the controlling postings, balancing those previously made 
individually to the customers' and creditors' accounts in the 
respective subsidiary ledgers. By so doing the general ledger 
is kept in balance, having $8690.00 Total Debits offset by 
$8690.00 Total Credits. 

PURCHASE JOURNAL 

It will not be necessary to redesign the purchase journal. 
Postings from the old form will be a little different and more 
complete, however, because of the Accounts Payable Controlling 
Account. A purchase journal with a few purchases to be re- 



CONTROLLING ACCOUNTS 139 

corded to Accounts Payable of the Holland Grocery Company is 
presented here so that a practice set which is to be presented 
shortly may utilize this book. 

PURCHASE JOURNAL 



Date 


Account Credit 


Purchase Order No. 


F 


Amount 


Nov. 


4 


Newark Grocery Co. 


13729 




4,200 


oo 




6 


Wilburt Supply Co. 


13730 




1,700 


oo 




8 


Chieftain Products Corp'n 


i373i 




3,400 


oo 




10 


General Distributing Co. 


13732 




2,900 


oo 






Total Purchases Dr. 


Accounts Payable 


Cr. 


12,200 


oo 



Posting Instructions: The individual credits to the Accounts 
Payable accounts, will be made as before, except that now these 
accounts will be found in a new subsidiary ledger. The total 
debit as before must, of course, be made in total to the Pur- 
chases account in the general ledger. In addition a credit for 
the total purchases must be entered in the Accounts Payable 
Controlling Account in the general ledger. 



CASH DISBURSEMENTS JOURNAL WITH CONTROLLING 

ACCOUNTS 

The Cash Disbursements book illustrated on the following 
page is designed to record all cash paid out by the business. The 
first column to the right of the date column is headed Account 
Debit. Herein is written the name of the account to be charged 
with the cash disbursement. Every account listed will be 
debited, some in the general ledger, others in the accounts pay- 
able ledger. The next two columns are devised to keep the 
groups of accounts separate. The first money column is de- 
signed to list miscellaneous general ledger accounts similar to 
the General Ledger column in the cash receipts book. The 
accounts entered in this column are posted separately from day 
to day. The Accounts Payable Controlling column is designed 
to keep all accounts paid to creditors, and these amounts are 
posted from day to day to the debit of the various creditors' 
accounts in the accounts payable ledger. The total of the Ac- 
counts Payable column at the end of the accounting period is 
posted as a debit to the Accounts Payable Controlling account 



140 



FUNDAMENTALS OF ACCOUNTING 



in the general ledger. This keeps the general ledger in balance 
with the subsidiary accounts payable ledger. The amounts en- 
tered in the first two money columns are the gross amounts to 
be debited, while the discount taken is recorded in the next col- 
umn to the right. The total discounts taken are posted only 
once a month, or at the end of any other accounting period. 
The net amount disbursed, similarly, is posted only in total, to 
the credit of the Cash account in the general ledger. 



CASH DISBURSEMENTS 



Date 


Account Debit 


Explanation 


F 


Gen. 
Ledger 
Dr. 


Accts. 
Payable 
Dr. 


Purch. 
Disc't. 
Cr. 


Net Cash 
Paid 
Cr. 


Nov. 


i 


Newark Grocery Co. 
Rent 
Wilburt Supply 
Salaries 
Chieftain Products 
Corp'n 
Heat & Light 
General Distribut- 
ing Co. 

General Ledger 
Accounts Payable Coi 
Purchase Discow 
Cash 


less 2% 
for month 
less 2% 
for week 

less 2% 
for month 

paid after 
disc't. per'd 

itrolling 
its 




200 
750 

96 


oo 

00 

oo 

00 


6,400 
2,000 

1,500 

3,280 


oo 
oo 

00 
oo 


128 
40 

30 
"198 


oo 
cx> 

oo 


6,272 
200 
I,g6o 
750 

1,470 
90 

3,280 


00 
00 

oo 
oo 

oo 

00 

oo 


i ,046 


13,180 


oo 


oo 


14,028 


oo 




Dr. 




Cr. 












V 


1,046 
13,180 


00 

oo 


108 
14,028 


oo 
oo 


14,226 


14,226 


00 



The summary posting is indicated just below the last entries. 
The General Ledger debit is checked because the items have 
already been individually posted to the general ledger. The 
next debit is to the Accounts Payable Controlling Account, and 
is made although the separate items were posted to the individual 
accounts. This is so because the individual posting is made to 
the subsidiary ledger, while the summary posting is made to the 
controlling account in the general ledger. The postings to the 
credit of the Discount on Purchases and Cash accounts are made 
in summary. This completes the summary posting to the gen- 
eral ledger; total debit postings are equaled by total credit post- 
ings, in this instance the amount is $14,226. Thus the equilib- 
rium of the general ledger is maintained. 



CONTROLLING ACCOUNTS 



141 



PRACTICE SET FOR ACCOUNTS RECEIVABLE 

At this time it might be well to work out a short practice set, 
in which we can illustrate the principles so far presented. In 
doing this we shall select the first five customers' accounts of 
the Holland Wholesale Grocery Company, and post to these ac- 
counts, and to the Accounts Receivable Controlling Account the 
entries affecting these accounts which are written in the jour- 
nals just presented. 

Let us suppose that the Holland Wholesale Grocery Com- 
pany's accounts receivable totaled only $9200.00 and consisted 
of just five customers with balances as listed before. Such a 
number of accounts would not, of course, warrant subdividing 
the general ledger; but we shall do that very thing, using the five 
accounts, in theory, at least, exactly as we should handle 240 
in actual practice. 

Step No. i. Five customers' accounts are transferred. 

ACCOUNTS RECEIVABLE LEDGER 

Customer i Customer 2 



Balance 1400.00 



Balance 1600.00 



Customer 3 



Customer 4 



Balance 3200.00 



Balance 1800.00 
Customer 5 



Balance 1200.00 



Step No. 2 . In the General Ledger we must place the following 
controlling account: 

ACCOUNTS RECEIVABLE CONTROL 



Balance of ac- 
counts trans- 
ferred 9200.00 



Step No. 3. Let us suppose that the transactions from the sales 
book, cash receipts book, and general journal affecting these 



142 



FUNDAMENTALS OF ACCOUNTING 



five customers have been posted, then the accounts would look 
as follows. And assume also that the summaries, as they would 
affect these same five accounts, were posted in the Accounts 
Receivable Controlling Account. 

ACCOUNTS RECEIVABLE LEDGER 

Customer i Customer 2 



Balance 
S.J. 


1400.00 
3500.00 


C.R. 1900.00 


Balance 1600.00 
S.J. 3400.00 


C.R. 


1 200.00 




Customer 3 


Customer 4 




Balance 
S.J. 


3200.00 
1900.00 


C.R. 3200.00 


Balance 1800.00 
SJ. 3900.00 


C.R. 
Rets. \ T 
Note / J 


900.00 
300.00 
2500.00 


Customer 5 






Balance 1 200.00 


C.R. 800.00 







S.J. 2800.00 



GENERAL LEDGER 

ACCOUNTS RECEIVABLE CONTROL 



Total Balances Trans- 
ferred 9200.00 
Total Sales SJ. 15500.00 



Total Cash Received 

from customers C.R. 8000.00 

Notes reed, and Sales rets. 
(from spl. col. in general 
journal) J. 2800.00 



SUMMARY OF PRACTICE SET 

If each customer's account is balanced, we shall note Cus- 
tomer i owes us exactly $3000.00; Customer 2 owes $3800.00; 
Customer 3 owes $1900.00; Customer 4 owes $2000.00 and 
customer 5 owes $3200.00, or a grand total of $13,900.00. This 
amount is the exact balance of the Accounts Receivable Con- 
trolling Account. 

PRACTICE SET FOR ACCOUNTS PAYABLE 

At this point we shall present a practice set for Creditors' 
accounts and Accounts Payable Controlling Account, very simi- 
lar to the case completed for the Accounts Receivable. 



CONTROLLING ACCOUNTS 143 

Let us take for our example the first four creditors' accounts 
of the Holland Wholesale Grocery Company, and treat them 
exactly as we might treat three or four hundred creditor ac- 
counts in actual practice. 

Step No. i removes these accounts from the general ledger 
to their new home in the Accounts Payable Ledger, which is 
illustrated below. 

ACCOUNTS PAYABLE LEDGER 

Newark Grocery Company Wilburt Supply Co. 



Balance 1 7 , 500.00 
Chieftain Products Corp'n 



Balance 8,950.00 
General Distributing Co. 



Balance 24,720.00 



Balance 16,880.00 



Step No. 2 will establish an Accounts Payable Controlling Ac- 
count in the general ledger. 

ACCOUNTS PAYABLE CONTROL 



Total Balances of accounts 

transferred 68,050.00 

Now, let us suppose that the transactions from the purchase 
record, the cash disbursements book, and the general journal 
have been posted to the four creditors 7 accounts in the accounts 
payable ledger, and that the summaries have been posted to the 
Accounts Payable Controlling Account in the general ledger. 
Then the two ledgers would appear as follows: 

ACCOUNTS PAYABLE LEDGER 

Newark Grocery Company Wilburt Supply Co. 



C.D. 



6,400.00 



Balance 17,500.00 C.D. 2,000.00 
P. 4,200.00 J. Returns 650.00 



Balance 8,950.00 



P. 



1,700.00 



Chieftain Products Corp'n 



General Distributing Co. 



C.D. 



1,500.00 



Balance 24,720.00 
P. 3>4-o 



C.D. 3,280.00 
J. Note 5,000.00 



Balance 16,880.00 
P. 2,900.00 



144 



FUNDAMENTALS OF ACCOUNTING 



GENERAL LEDGER 
ACCOUNTS PAYABLE CONTROL 



Total cash paid C.D. 13,180.00 

Total from Spl. Col. in 

Journal J. 5,650.00 



Balance of accounts opened 68,050.00 
Total Purchases P. 12,200.00 



SUMMARY OF PRACTICE SET 

If each creditor's account is balanced we shall note that the 
business owes the Newark Grocery Company $15,300.00; the 
Wilburt Supply Co. $8000.00; the Chieftain Products Co. 
$26,620.00, and the General Distributing Co. $11,500.00, or a 
grand total due Creditors of $61,420.00. Now, if the Accounts 
Payable Controlling Account is balanced, a credit balance of an 
exactly equal amount will be the result. 



OTHER CONTROLLING ACCOUNTS 

The two controlling accounts just studied are the most widely 
used controlling accounts. There are, however, situations which 
arise in some businesses which can best be served by the intro- 
duction of special subsidiary ledgers and appropriate controlling 
accounts. Often in a manufacturing company, where there are 
a great many pieces of machinery, rather than try to keep all 
machinery and equipment in one account, the Machinery and 
Equipment account may be maintained in the general ledger 
as a controlling account; while in a subsidiary machinery ledger 
an account frequently in the form of a card will be maintained 
for each piece of machinery owned. Such cards will show the 
exact cost of each machine and any other information which 
will be helpful in controlling this valuable asset. As expendi- 
tures are made for machinery, appropriate entries are made in 
the machinery ledger, and at the end of the period summaries 
of the entries affecting machinery will be posted to the control- 
ling account. Similarly, if a company owns several parcels of 
real estate and buildings, a real estate ledger and corresponding 
Real Estate Controlling account would be appropriate. If a 
company owns many mortgages, it might be a good idea to set 
up a mortgage ledger, in which could be maintained individual 



CONTROLLING ACCOUNTS 145 

records for each mortgage held. If such a subsidiary ledger 
were kept, then an appropriate controlling account such as 
Mortgages Receivable would have to be placed in the general 
ledger to take the place of the several mortgage accounts trans- 
ferred. It may be noted, then, that in practice a subsidiary 
ledger and related controlling account may be established any 
time a group of similar accounts grows to the point where it is 
felt advantageous to segregate the accounts. 

ADVANTAGES OF CONTROLLING ACCOUNTS 

In general, and briefly, the benefits derived from the use of 
controlling accounts and subsidiary ledgers are as follows : 

(1) The trial balance of the general ledger is shortened by 
the removal of each group of similar accounts. Therefore the 
work of preparing the trial balance is shortened, and since there 
are fewer accounts the likelihood of error is greatly reduced. 
The preparation of statements is simplified by the shorter trial 
balance of the general ledger. 

(2) Not only are the errors in the general ledger greatly 
reduced, but by keeping all similar accounts together the likeli- 
hood of errors in the subsidiary ledgers is also reduced. This 
is true because bookkeepers working on only one type of ac- 
count become highly skilled, and the chance of their making 
careless errors is greatly reduced. The controlling accounts are 
usually conceded by experienced bookkeepers to be correct, 
because so few entries are made. Therefore, if the list of sub- 
sidiary ledger accounts agrees with the controlling account 
balance the bulk of the bookkeeping work for the period may 
be conceded to be correctly done. 

QUESTIONS ON THE CHAPTER 

1. Why is it necessary to subdivide the general ledger? 

2. What advantages are there to subdividing the general ledger? 

3. Briefly state your idea of a controlling account. Illustrate and 
give the functions of one. 

4. Should the total of the balances in the subsidiary ledger always 
agree with the balance of the controlling account? If there is dis- 
agreement what are some of the likely causes of difficulty? Which 
total is more likely to be correct? Why? 

5. Post the following summarized information to two appropriate 
controlling accounts: 



146 FUNDAMENTALS OF ACCOUNTING 

The balance due from Customers at November ist was 
$20,000; Total purchases for November amounted to $33,000; Sales 
for the same period were $32,000; Sales Returns amounted to $2000; 
Purchase Returns amounted to $1200; Total Cash Received from 
Customers amounted to $28,000; Total Cash Paid to Creditors was 
$22,800. 

Notes in amount of $5000 were received from customers. 
Notes were given to firm creditors in amount of $6000. 

6. How are responsibility and accuracy promoted by the use of 
controlling accounts? 

7. If you were head bookkeeper for a large mercantile organiza- 
tion and had two assistants to help you, what work in general would 
you assign to each assistant? Why? 

8. If you were head bookkeeper, and your Accounts Receivable 
Controlling account showed $64,000 due from customers, and the as- 
sistant bookkeeper who operated the accounts receivable ledger took 
off a list of open balances totaling $64,520, 

(a) Which balance is most likely correct? Why? 

(b) What error might be responsible for such a situation? 

9. Explain the posting of the sales book: 

(a) With reference to individual accounts. 

(b) With reference to controlling account. 

(c) Show how the general ledger is kept in balance. 

10. Explain the operation of the purchase journal: 

(a) With reference to posting to individual accounts. 

(b) Indicate how balance is maintained in the general ledger 
through summary posting. 

1 1 . Explain how double posting is avoided when cash sales are kept 
in both the sales book and the cash receipts journal. 

1 2 . Explain the summary posting of : ( a ) the cash receipts journal : 
(b) The cash payments journal. 

13. (a) Describe the six-column form of general journal, and give 
the functions of each column. 

(b) Give advantages of using such a journal. 

14. List and discuss briefly the advantages of Controlling Accounts 
and subsidiary ledgers. 

15. (a) Draw a large T ledger account for the Accounts Receivable 
Controlling account and write in the debits and credits which are 
made each month; also explain what the balance represents. 

(b) Do the same for the Accounts Payable Controlling ac- 
count. 

PROBLEM MATERIAL 

PROBLEM i 
February 4, IQ . 

T. Riley starts business as a mill representative, dealing directly 
at wholesale with department stores. His investment consists 



CONTROLLING ACCOUNTS 147 

of the following: Auto Equipment, used, but conservatively val- 
ued at $4000.00; a stock of merchandise also conservatively 
valued at $2400.00; Land & Building to be used as a storage 
warehouse and office owned free and clear, conservatively valued 
at $6000.00. Notes Payable $3000.00. In addition Mr. Riley 
has $8000.00 which he places to his business account. 
A shipment with invoice arrives from the Morrison Mills total 

$1200.00 terms 3/10 11/30. 
February 5. 

Paid by check $16.00 for printing and stationery. 
February 6. 

A purchase with invoice arrives from the Trenton Mills total 
$3000.00 terms 3/10 n/3o. Sold to Wanamakers Inc. total 
$324.00 (all sales are on account and terms are uniform 2/10 
n/3o). 
February 7. 

Cashed a check for $12.00 for postage stamps. 
February 8. 

Sold to Taylor & Lords $414.00. Purchased from Hampton Inc. 

$680.00 terms i/io n/30. 
February 9. 

We returned some damaged merchandise received from Hampton 

Inc. and issued a debit memo for $30.00. 
February 10. 

Received a check $317.52 from Wanamakers Inc. as payment in 

full invoice Feb. 6. 
February 12. 

Purchase received from Shetland Mills invoice total $940.00 terms 
2/10 n/30. Sold to Gimbels Inc. $618,00. Sent our check 
$1164.00 to the Morrison Mills invoice Feb. 4 in full. Received 
a check from Taylor & Lords $405.72 invoice of Feb. 8. 
February 14. 

Sent our check to Trenton Mills $2910.00 invoice Feb. 6 in full. 
Sold to Saks & Co. $720.00. Received a shipment with invoice 
from Morrison Mills total $1380.00 terms 3/10 11/30. 
February 15. 

Sent our check to Hampton Inc. $643.50 payment in full invoice 
Feb. 8 less debit memo. Gave our check for $214.00 to the tax 
collector as payment of the first half year's taxes due today. 
February 16. 
.Sold to Taylor & Lords $860.00. A purchase and invoice arrived 

from Hampton Inc. total $1000.00 terms i/io n/30. 
February 18. 

Sold to Gimbels Inc. $920.00. A shipment and invoice arrived 
from the Trenton Mills total $2100.00 terms 3/10 11/30. Pur- 
chased stationery & letterheads $24.00 for which check is 
drawn. A check for $605.64 was received from Gimbels Inc. 
Payment invoice Feb. 12 in full. 



148 FUNDAMENTALS OF ACCOUNTING 

February 20. 

Sold to Wanamakers Inc. $540.00. A purchase and invoice arrived 
from the Shetland Mills total $910.00 terms 2/10 n/3o. Re- 
ceived a check $705.60 from Saks & Co. for invoice of Feb. 14 
in full. 

February 21. 

Sent check to the Shetland Mills for invoice of Feb. 12 in full 
$921.20. 

February 24. 

Sold to Saks & Co. $964.00 and to Taylor & Lords $526.00. Ship- 
ments arrived from Hampton Inc. $1400.00 terms i/io n/3O and 
from the Morrison Mills $1420.00 terms 3/10 n/3O. Purchased 
for cash twine for shipping department; total was $6.40 with a 
2% discount. Our check was $6.27. 

February 25. 

Received Taylor & Lord's Check $842.80 on payment in full Feb. 
1 6 invoice. 

February 26. 

Sold to Gimbels Inc. $714.00. Received a shipment and invoice 
from the Trenton Mills $870.00 terms 3/10 n/3o. We received 
some merchandise valued at $62.00 returned from Saks & Co. 
as not per sample; we issued a credit memo. Received a ship- 
ment of boxes, paper and other wrapping materials from Gair 
Box Co. total $310.00 terms 3/10 n/3O. 

February 28. 

Paid salaries for the month total $600.00. Sent our check for 
$2037.00 to the Trenton Mills for invoice Feb. 18 in full. Re- 
ceived a check from Wanamakers Inc. $531.20 invoice Feb. 28 
in full. A purchase and invoice arrived from Shetland Mills to- 
tal $1300.00 terms 2/10 n/3O. Made sales to Wanamakers Inc. 
$800.00 and Saks & Co. $410.00. A check of Gimbels invoice 
of Feb. 26 reveals an error in billing, correct amount should have 
been $724.00. We send a corrected invoice with a letter of ex- 
planation. 

Required: 

1 i ) Enter the transactions above as directed. 

( 2 ) Total and post all special journals. 

(3 ) Trial balance of general ledger. 

(4) Prove totals of controlling accounts with totals of subsidiary 
ledgers. 

PROBLEM 2 
December r. 

Mr. George K. Hawkins starts business this day with a cash invest- 
ment of $12,000.00. You are to open a Purchase Journal, a 
Sales Journal, a Cash Receipts Journal, a Cash Payments Jour- 
nal, and a six-column general journal form as illustrated in Chap- 
ter IX. You are to operate beside the General Ledger two sub- 



CONTROLLING ACCOUNTS 149 

sidiary ledgers, one for Accounts Receivable and the other for 
Accounts Payable. Enter the foregoing investment and the fol- 
lowing selected transactions. Paid December rent to the Mutual 
Realty Co. $320.00. A shipment arrived from the Northern Fur 
Company together with an invoice in amount of $1800.00 terms 
2/10 n/30, also a shipment and invoice from the Brockton Shoe 
Co., total $2400.00 terms 2/10 11/30. Sold to A. Diebolt 
$720.00 (all sales unless otherwise noted are on account and with 
uniform credit terms namely 2/10 n/3o). 
December 2. 

Sold on account to L. Ketchum $810.00. Received shipments and 
invoices from the Morton Supply Co., total $720.00, and from 
the General Supply Co., total $1200.00. (These and all other 
purchases are made on uniform credit terms 2/10 n/3O.) 
December j. 

Sold to B. Lynch $965.00. 
December 4. 

Drew a check for $12.00 and cashed it at our bank for purchase 

of postage stamps. Sold to S. Wilkes $320.00. 
December 5. 

Mr. Hawkins authorizes you to draw a check for $100.00 to estab- 
lish a petty cash fund. 
December 6. 

We return shoes, which arrived in a damaged condition, to the 
Brockton Shoe Co. and they allow full credit $40.00. Mr. Haw- 
kins requests you to draw a check for $125.00 in payment of a 
new typewriter for your office, which he just purchased. There 
were sundry cash sales for the week which total $270.00. 
December 7. 

Sold to F. Smith $480.00. 
December 8. 

Sold to B. Lynch $715.00. Received a check in amount of $705.60 
from A. Diebolt payment of invoice of December i. Received 
an invoice and shipment from the Brockton Shoe Co., $1800.00. 
December g. 

Received a shipment and invoice from the Northern Fur Co. in 
total $2000.00. Received a check from L. Ketchum $793.80 
payment of invoice of December 2. Sold to L. Ketchum $752.00. 
Paid by check express charges $22.00. 
December 10. 

Paid by check Northern Fur Co. Invoice of December i less the 
discount and paid the Brockton Shoe Co. their invoice of De- 
cember i less the discount. 
December n. 

Sold to S. Wilkes $980.00. Received a check from B. Lynch 
$945.70 full payment invoice of December 3. Sent checks to 
the Morton Supply Co. for their invoice of Dec. 2 less the dis- 



1 50 FUNDAMENTALS OF ACCOUNTING 

count, and the General Supply Co. for their invoice of Dec. 2 
less the discount. 
December 12. 

Mr. Hawkins asks you to draw a check to his order in amount of 
$200.00 for his personal use. (Open a drawing account for 
Mr. H.) 
December i j. 

Received a check $313.60 from S. Wilkes for his invoice of Dec. 4. 

There were sundry cash sales for the week in total $310.00. 
December 15. 

Mr. Hawkins gives you his personal check for $3000.00 which you 
are to deposit as an additional investment. Sold to A. Diebolt 
$440.00. A credit memo is sent to L. Ketchum $32.00 for mer- 
chandise returned not as per sample. 
December 16. 

Mr. Hawkins requests you to draw a check to the order of the 
Globe Advertising Agency $600.00 advertising to date; and a 
check for $425.00 for salaries to Dec. 15. Received a check 
$470.40 from F. Smith for his invoice of Dec. 7. Purchases 
from the General Supply Co. $1400.00. Sold to B. Lynch 
$325.00. Purchased Morton Supply Co. $840.00. 
December 17. 

A check of the invoice sent to B. Lynch indicates an error in billing 
of $15.00, the total should have been $340.00. Mr. Hawkins 
asks you to send out a corrected invoice with a letter of explana- 
tion. A check is drawn for $46.00 payment of hauling charges 
to date. A check $1764.00 is sent to the Brockton Shoe Co. full 
payment of invoice of Dec. 8. 
December 18. 

Sold to L. Ketchum $448.00. Purchased from Brockton Shoe Co. 
$1740.00. Received a check $705.60 from L. Ketchum for in- 
voice of Dec. 9 and also a check $700.70 from B. Lynch for in- 
voice of Dec. 8. Sent our check to the Northern Fur Co. full 
payment of Dec. 9 invoice. 
December 20. 

Sundry cash sales for the week totaled $280.00. Received a check 

from S. Wilkes for invoice of Dec. u. 
December 21. 

Sold to S. Wilkes $780.00. Purchased from Northern Fur Co. 

$1600.00. 
December 22. 

Purchased a delivery truck from the White Truck Co. total deliv- 
ered price $2200.00, for which we gave a check for $700.00 and 
signed finance notes for the balance. 
December 23. 

Took out a Fire, Theft, and Public Liability Insurance policy from 
the Globe Insurance Co. total cost $230.00 terms net 30 days. 
Received a shipment and invoice from the General Supply Co. 



CONTROLLING ACCOUNTS 151 

$1600.00. Mr. Hawkins requests a $300.00 check for his per- 
sonal use. Sold to F. Smith $220.00 and to A. Diebolt $540.00. 
December 24. 

Sent a check to the Morton Supply Co. $823.20 full payment in- 
voice Dec. 16; purchased two new filing cabinets for cash $64.00 
from Steel Equipment Co. Received a check from A. Diebolt 
$431.20 full payment invoice of Dec. 15. Also a check from 
B. Lynch for Dec. 16 invoice in full. Sent check to General 
Supply Co., amount $1372.00 for invoice Dec. 16. 
December 27. 

Sundry cash sales for the week were $240.00. Purchased from 
Brockton Shoe Co. $1260.00. We issued a credit memo to 
F. Smith for damaged goods returned $28.00. 
December 28. 

Sold to F. Smith $446.00. Paid express charges to date $81.00. 

Drew a salary check $464.00. 
December 29. 

Purchased from the Morton Supply Co. $915.00. 
December 30. 

Purchased from the General Supply Co. $1825.00. Sold to 
L. Ketchum $324.00. 

Required: 

1 i ) Enter transactions above in special journals as directed. 

(2) Total and post all special journals. 

(3) Trial balance of general ledger. 

(4) Prove totals of controlling accounts with totals of subsidiary 
ledgers. 



CHAPTER X 

ACCOUNTING AT THE END OF THE FISCAL 

PERIOD 

PURPOSE AND PLAN OF CHAPTER 

In the first two chapters the importance of financial state- 
ments and their general content were studied. Now that the 
principal steps in the routine bookkeeping cycle have been dis- 
cussed, we are ready to study the very interesting accounting 
work required at the close of the fiscal period to complete the 
bookkeeping or accounting cycle, as it is sometimes called. 

In order that the student may co-ordinate the several steps 
required at the close of the accounting period, the material in 
this chapter is presented in its briefest possible form. The ac- 
counting work required at the close of the fiscal period is, of 
course, so important that several subsequent chapters will be 
devoted to a more complete and detailed study of this most 
interesting work. Our one purpose in this chapter is to present 
the student with a bird's-eye-view of what takes place in the 
accounting department at the close of the fiscal period. 



THE BOOKKEEPING CYCLE 

At this point it may be well to review the several steps in the 
complete bookkeeping or accounting cycle, as it is sometimes 
called. 

1 . Journalizing. Recording the transactions in their respec- 
tive journals. 

2. Posting. Procedure of transferring entries from the books 
of original entry to the ledger accounts. 

3. Taking a Trial Balance. Summarizing the ledger accounts. 

4. Adjusting the Books. Determining the adjustments neces- 
sary so that the accounts will reflect the correct and true 
conditions. 

(These are to be studied in this and subsequent chapters.) 

5. Preparing the Work Sheet. An accountant's device for 

152 



ACCOUNTING END OF PERIOD 153 

classifying accounts, to be used as basis for preparation of 

financial statements. 

(To be studied in this and subsequent chapters.) 

6. Preparing the Financial Statements. Preparing the profit 
and loss statement and balance sheet from the work sheet. 
(To be studied in this and subsequent chapters.) 

7. Closing the Books. Recording the adjusting and closing 
entries in the general journal, posting these entries to the 
ledger. Ruling the accounts. 

(This work also will be studied in this and subsequent 
chapters.) 

8. Taking a Post-Closing Trial Balance. Procedure of test- 
ing the accuracy of closing the books. 

The eight steps outlined above constitute the accounting ac- 
tivities that are usually repeated during each accounting period. 
The first three steps have already been presented, while the 
remaining steps are now presented one at a time in their briefest 
possible form, so that the entire procedure may be viewed as 
parts of a complete procedure. Subsequent chapters, as was 
stated before, will develop these steps. 



THE ACCOUNTING PERIOD 

The annual accounting period, or fiscal yearly period, is used 
in modern business for the purpose of preparing formal annual 
statements and the summing up of the year's business, but for 
managerial control the year period is far too long. The year is 
usually divided into a series of much shorter periods to make 
possible the comparison of earnings and expenses of one period 
with those of other similar periods. Such comparisons are 
valuable to the management; first, in testing the current stand- 
ards with the past records, and, secondly, in formulating and in- 
augurating the future policy of the organization. Probably the 
most widely used accounting period today is the calendar month, 
although some progressive organizations have gone so far as to 
divide the year into thirteen equal periods of four weeks each. 
The length of the accounting period is, of course, an arbitrary 
matter, and each individual concern will decide in accordance 
with what best suits its particular needs. 



154 FUNDAMENTALS OF ACCOUNTING 

NEED FOR ADJUSTMENTS 

At the end of the accounting period after the last entries have 
been written in the journals and posted to the ledger, a trial 
balance is prepared. This is the starting point for the prepara- 
tion of financial statements. The routine bookkeeping work 
for the period is concluded. During the accounting period, how- 
ever, certain things have been happening for which adequate 
accounting records could not be conveniently kept. Despite the 
fact that throughout the accounting period every current trans- 
action may have been recorded correctly and every debit and 
credit posted properly and, finally, an accurate trial balance 
prepared, the books will not show all the essential facts needed 
for the preparation of the Profit and Loss Statement and the 
Balance Sheet. 

Assets have been depreciating for which a reserve will have 
to be calculated. The probable loss on doubtful accounts will 
have to be calculated as an expense to be included in the current 
accounting period. Therefore certain adjustment entries will 
have to be written and posted to the books before they reflect 
the companies' true financial condition. After all adjusting en- 
tries have been written, the books will be ready to be closed. At 
this time only one adjustment entry will be studied as an ex- 
ample; further adjustments, as stated before, will be taken up 
at length in a subsequent chapter. 

ADJUSTMENT FOR MERCHANDISE INVENTORY 

One very important adjustment entry which should be made 
at the close of each accounting period, if the financial state- 
ments prepared at that time are to reveal the true financial con- 
dition of the organization, is one which will adjust for the value 
of the current merchandise inventory. The trial balance taken 
at the close of the period will show an inventory account, but 
the amount listed is the value of the goods which were on hand 
at the start of the period. These goods probably have been sold, 
and more purchased. The total merchandise purchased is also 
listed on the trial balance, but ordinarily all of these goods will 
not be sold. The amount remaining unsold at the end of the 
accounting period should be determined, and by means of an 
adjusting entry placed in the inventory account as an asset. 



ACCOUNTING END OF PERIOD 155 

In order to determine the value of the unsold merchandise, a 
physical inventory is usually taken. In brief, all stock on hand 
is listed and a value ascribed to each article, after which the 
values are totaled. Inventory-taking may be a very simple 
affair or a really complex proposition, depending on the type 
of business, size, quantity, and description of stock. 

The inventory taken at the end of the account period is tech- 
nically known as the closing or " New " inventory. This same 
inventory, after the books have been closed, automatically be- 
comes the " Old " inventory, because at the close of the next 
accounting period a " New " inventory must be taken. 

At this point it might be helpful to introduce an illustration 
to make clear what we mean by " Old " and " New " inventories. 

If a man starts business with nothing but a cash investment 
and purchases all the merchandise he intends to sell, at the end 
of his first accounting period he will have only the " New " 
inventory and Purchases to reckon with. When the next period 
starts he will have on hand this stock to continue business with; 
he will purchase more stock, and at the close of the first period 
the former " New Inventory " will then be treated as the " Old " 
or beginning inventory, and a " New Inventory " will have to be 
determined. Let us illustrate these two accounting periods 
graphically, in statement form, showing the relation between 
periods and inventories: 

First Second 

Period Period 
Inventory at beginning of period, also called 

" Old " inventory o.oo $ 300.00 

Purchases added to stock $1000.00 1500.00 

Total available for sale 1000,00 1800.00 

On hand at close of period, also called " New " 

inventory 300.00 650.00 

Purchases consumed, or the cost of goods sold $ 700.00 $1150.00 

The value of merchandise on hand at the close of the first 
accounting period is $300.00, and, it will be noted, the same 
amount is termed " Old Inventory " at the start of the next ac- 
counting period; and so the $650.00 amount, the "New In- 
ventory " at the close of the second period, will be the " Old 
Inventory " at the start of the third accounting period. 

In practice the terms Old Inventory, Beginning Inventory, 



156 



FUNDAMENTALS OF ACCOUNTING 



and Opening Inventory are widely used to refer to the stock on 
hand at the start of the accounting period, while the inventory 
on hand at the end of the accounting period in contrast is known 
as New Inventory, Ending Inventory, or Closing Inventory. Of 
course, there is but one inventory account in the ledger; these 
terms just referred to simply are convenient terms used to dif- 
ferentiate between inventory balances at different dates. It is 
a very good practice to date each inventory carefully, as in 
accounts and on financial statements all references to inven- 
tories should be by date. 



ADJUSTING ENTRY ILLUSTRATED 

As an example, let us suppose the following is a trial balance 
taken from the books of the Dudley Furniture Company at 
December 31, 19 . 



i. 

2. 
3. 
4. 
5. 
6. 



Cash 

Accounts Receivable Control 

Delivery Equipment 

Land & Buildings 

Notes Receivable 

Furniture & Fixtures 



7. Inventory Merchandise June 30, 



8. 

9. 
10. 
ii. 
12. 
13. 
14. 
15. 
16. 
17. 
18. 
19. 
20. 



Purchases 

Delivery Expense 

Salaries 

Insurance 

Stationery & Supplies 

Interest Expense 

Interest Income 

Accounts Payable Control 

Sales 

Advertising Expense 

Notes Payable 

Mortgages Payable 

Taxes 



21. John Dudley Capital 



$ 2,646.45 
13,343.60 

4,500.00 

20,000.00 

2,000.00 

2,400,00 

6,500.00 

71,280.00 

1,630.00 

2,470.00 

240.00 

620.00 

125.00 



2,360.00 

895.00 
$131,010.05 $131,010.05 



240.00 
22,050.05 
83,270.00 

4,500.00 

12,000.00 
8,950.00 



A physical inventory has been taken as of December 19 
which indicates a stock of merchandise on hand valued at 



20.00. 



ACCOUNTING END OF PERIOD 



157 



ADJUSTMENT ENTRY FOR THE NEW INVENTORY 

In adjusting and closing the books it will be convenient to 
make use of a temporary summary account, opened at the close 
of each accounting period, called the Profit and Loss Summary. 
This account is opened on the books when the New Inventory is 
added by the following adjusting entry: 

GENERAL JOURNAL 

-i- 

Inventory December 31, 19 $8420.00 

Profit and Loss Summary $8420.00 

To record the asset value of the New Inventory. 

After this entry has been written, another entry transferring 
the* Old Inventory to the Profit and Loss Summary is usually 
written as follows: 

GENERAL JOURNAL 

-2- 

Profit and Loss Summary $6500.00 

Inventory June 30, 19 $6500.00 

To transfer the cost of the Old Inventory to the Profit and Loss 

Summary 

At this time, if we were to post the two foregoing journal en- 
tries, the Inventory account and the Profit and Loss Summary 
account would appear as follows : 



INVENTORY 



June 30 $6500.00 

Dec. 31 Adjustment (i) 8420.00 



Dec. 31 Transferred to 

Profit & Loss (2) 



$6500.00 



PROFIT AND Loss SUMMARY 



Dec. 31 Old Inventory (2) $6500.00 



Dec. 31 New Inventory (i) $8420.00 



158 FUNDAMENTALS OF ACCOUNTING 

The Inventory account is now properly adjusted, revealing 
an asset balance of $8420.00. Before we go further with our 
closing procedure, it will be helpful to present at this point The 
Accountant's Work Sheet. 









































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ACCOUNTING END OF PERIOD 159 

THE ACCOUNTANT'S WORK SHEET 

The form on page 158 is a device used by accountants to aid 
in the preparation of financial statements. By use of this form 
the accountant can visualize the entire process of adjusting and 
closing the books without reference to the general ledger. By 
means of distributive columns the Profit and Loss and Balance 
Sheet accounts are classified and the profit or loss for the period 
is quickly ascertainable. 

The best way to understand the use of the Work Sheet is to 
study the form in detail. The first two money columns are re- 
served for the trial balance before adjustment. The next two 
money columns are marked Adjustments Dr. & Cr. These two 
columns are reserved for the adjustment entries. Following this 
are four more money columns. The first two are headed Profit 
and JLoss, Dr. & Cr. while the last two are marked Balance 
Sheet, Dr. & Cr. All expense accounts are distributed to the 
Expense Dr. column, while the income accounts are placed in 
the next column headed Income Cr. 

In a similar manner the Balance Sheet accounts are dis- 
tributed to the last pair of money columns. The next to the last 
column is reserved for Asset accounts, while Liability and Net 
Worth accounts are placed in the last column to the right. If 
the last four money columns are added, it will be noted that the 
totals of two respective pairs of debit and credit columns do not 
agree; but a very significant fact will be noted, that the dif- 
ference between each pair of columns is exactly the same. 
Should the credit column in the Profit and Loss group exceed the 
debit column, as is the case in our illustration, then, because 
income is greater than expense, a profit of $5810.00 is indicated. 
Similarly, in our illustration, the total of the Asset column ex- 
ceeded the total of Liabilities and Net Worth, by the same 
amount $5810.00 indicating also a profit for the period. 

PREPARATION OF FINANCIAL STATEMENTS FROM 
WORK SHEET 

The preparation of financial statements in finished form may 
now be started, and with the aid of the work sheet should be 
comparatively simple. 



160 FUNDAMENTALS OF ACCOUNTING 



THE PROFIT AND LOSS STATEMENT 

The standard form of profit and loss statement similar to 
that studied in Chapter III is now prepared, using the informa- 
tion taken from the accounts listed in the Profit and Loss column 
on the work sheet. 

JOHN DUDLEY 

Statement of Income, Profit and Loss for the six-months period 
ended December 31,1 9 

Income from sales .................... $83,270.00 

Deduct the " Cost of Goods Sold ": 

Merchandise Inventory June 30 ...... $ 6,500.00 

Add Purchases .................... JJ^^o^ 

Total Merchandise handled .......... $77,780.00 

Less Merchandise Inv. Dec. 31 ....... _ 

Cost of Goods sold ............... 

Gross profit on sales .................. $13,910.00 

Deduct the General and Administrative Expenses: 

Delivery Expense ................ $ 1,630.00 

Salaries ........................ 2,470.00 

Insurance ...................... 240.00 

Stationery & Supplies ............ 620.00 

Interest Expense ................. 125.00 

Advertising Expense ............. 2,360.00 

Taxes ......................... ____ 895.00 



Net profit on trading ................. $ 5,570.00 

Add interest income .................. 240.00 

Net profit for the period ........... $ 5,810.00 



THE BALANCE SHEET 



In a similar manner, using the accounts listed in the last two 
money columns, headed Balance Sheet Dr. & Cr., it will be 
quite a simple matter to prepare a formal Balance Sheet. 



ACCOUNTING END OF PERIOD 



161 



JOH\ DUDLEY 

BALANCE SHEET 
December 31, 19 



A ssets 




Cash 
Accounts Receivable 
Land and Building 
Delivery Equipment 
Notes Receivable 
Furniture & Fixtures 
Merchandise Inventory 


$ 2,646.45 
13,343.60 
20,000.00 
4,500.00 

2,000.00 
2,4OO.OO 
8,42O.OO 




$53,310.05 



Liabilities and Net \Yorth 



Liabilities 
Accounts Payable 
Notes Payable 
Mortgage Payable 

Total Liabilities 

A>/ Worth 

J. Dudley, Capital 

June 30 $8,950.00 
Add Profit for 

Period 5,810.00 



$22,050.05 
4,500.00 
1 2,000.00 

$3^,550.05 



14,760.00 
$53,310.05 



CLOSING THE BOOKS 

After the financial statements have been prepared and copies 
presented to the executives interested, it will be the accountant's 
next duty to see that the ledger accounts are properly closed and 
balanced. Closing entries are entries written in the journal to 
transfer all expense and income account balances to the Profit 
and Loss Summary account, so that the final net profit or loss 
may be determined and transferred to the proprietor's capital 
account, or to a surplus account in case of a corporation. After 
the closing entries have been posted, all the nominal accounts 
will have been closed, and they may be ruled off and left clear 
for the start of the next period. At the end of the year it is 
a good practice to balance the asset and liability accounts, so 
that their balances at that time will stand out. 



CLOSING ENTRIES 

The Profit and Loss Summary account now contains a debit 
and a credit as a result of the adjusting entries for the merchan- 
dise inventory. Our next step will be to write an entry trans- 
ferring all nominal accounts with credit balances to the Profit 
and Loss Summary; this will summarize all income. In a similar 
manner a compound entry will be written, transferring all ex- 
penses to the debit side of the Profit and Loss Summary and this 



1 62 FUNDAMENTALS OF ACCOUNTING 

will summarize all expense for the period. The final closing 
entry will transfer the balance from the Profit and Loss Sum- 
mary to the proprietor's capital account. 

GENERAL JOURNAL 

Closing Entries December 31, 19 
i 

Sales $83,270.00 

Interest Income 240.00 

Profit and Loss Summary $83,510.00 

To close the income accounts and transfer 
their balances to the Profit and Loss Sum- 
mary. 

2 

Profit and Loss Summary 79,620.00 

Purchases 71,280.00 

Delivery Expense 1,630.00 

Salaries 2,470.00 

Insurance 240.00 

Stationery & Supplies 620.00 

Interest Expense 125.00 

Advertising Expense 2,360.00 

Taxes 895.00 

To close the expense accounts and transfer 
their balances to the Profit and Loss Sum- 
mary account. 

-3- 

Profit and Loss Summary 5,810.00 

John Dudley, Capital 5,810.00 

To transfer the net profit for the period 
from the Profit and Loss Summary to Mr. 
John Dudley's Capital account. 

THE CLOSED LEDGER 

After the entries above have been posted, all the nominal 
accounts should be closed, and the ledger should look as follows : 

CASH i 



Dec. 31 Balance $ 2,646.45 

ACCOUNTS RECEIVABLE CONTROLLING 



Dec. 31 Balance $13,343.60 



ACCOUNTING END OF PERIOD 163 



Dec. 31 Balance 



Dec. 31 Balance 



Dec. 31 Balance 



Dec. 31 Balance 



Dec. 31 Balance 



LA xi) AND BUILDINGS 



$20,000.00 



DELIVERY EQUIPMENT 



$ 4,500.00 



NOTES RECEIVABL 

r 



$ 2,000.00 

i 

FURNITURE AND FIXTURES 

$ 2,400.00 ! 

MERCHANDISE INVENTORY 



June 30 Balance $ 6,500.00 

Dec. 31 Adjustment 

Entry No. i $ 8,420.00 



Dec. 31 Adjustment 



Entry No. 2 $ 0,500.00 



PURCHASES 



$71,280.00 



Dec. 31 Closing Entry 2 $71,2X000 



Dec. 31 Balance 



Dec. 31 Balance 



DETJVLRY EXPENSES 



$ i ,630.00 



Dec. 31 Closing Entry 2 $ I/MOOO 



S ALAR II, S 



$ 2,470.00 ; Dec. 31 Closing Entry 2 $ 2,470.00 



Dec. 31 Balance 



TNSUR \xrj. 



$ 240.00 Dec. 31 Closing Entry 2 $ 240.00 



Dec. 31 Balance 



STATIONARY AND SUPPLIES 



$ 620.00 Dec. 31 Closing Entry 2 $ 620.00 



1 64 FUNDAMENTALS OF ACCOUNTING 

INTEREST EXPENSE 



Dec. 31 Balance 



$ 125.00 



Dec. 31 Closing Entry 2 $ 125.00 



INTEREST INCOME 



Dec. 31 Closing Entry i $ 240.00 



Dec. 31 Balance 



ACCOUNTS PAYABLE CONTROLLING 



$ 240.00 



Dec. 31 Balance 



SALES 



$22,050.05 



16 



Dec. 31 Closing 

Entry No. i 



Dec. 31 Balance 



$83,270.00 
$83.270.00 



Dec. 31 Total 



ADVERTISING EXPENSE 



$ 2,360.00 



Dec. 31 Closing 

Entry No. 2 



NOTES PAYABLE 



$83,270.00 
$83,270.00 



$ 2,360.00 



18 



Dec. 31 Balance 



MORTGAGE PAYABLE 



$ 4,500.00 



Dec. 31 Balance 



TAXES 



$12,000.00 



20 



Dec. 31 Balance 



$ 895.00 



Dec. 31 Closing 



Entry No. 2 $ 895.00 



JOHN DUDLEY, CAPITAL 



21 



Dec. 31 Balance 
Dec. 31 Closing 

Entry No. 3 



$ 8,950.00 
5,810.00 



ACCOUNTING END OF PERIOD 

PROFIT AND Loss SUMMARY 



Dec. 31 Merchandise Inventory 

Adjustment No. 2 $ "6,500.00 
Closing Entry No. 2 $79,620.00 

Closing Entry No. 3 $ 5,810.00 
$91,930.00 



Dec. 31 Merchandise Inventory 

Adjustment No. i $ 8,420.00 
Closing Entry No. i $83,5 10.00 



$q i ,930 oo 



POST CLOSING TRIAL BALANCE 

After the books have been closed as a check of the accuracy 
of the work, a trial balance after closing is taken as the conclud- 
ing step. 

The following is a trial balance taken from the general ledger 
above after all closing entries have been posted: 

JOHN DUDLEY FURNITURE CO. 

Post Closing Trial Balance 
Cash i $ 2,646.45 



Accts. Receivable Control 2 

Land & Buildings 3 

Delivery Equipment 4 

Notes Receivable 5 

Furniture & Fixtures 6 

Mdse. Inventory, Dec. 31, 19 7 

Accounts Payable Control 15 

Notes Payable 18 

Mortgage Payable 19 

J. Dudley, Capital 21 



i3',343.6o 

20,000.00 
4,500.00 
2,000.00 
2,400.00 
8,420.00 

$22,050.05 

4,500.00 

12,000.00 

14,760.00 

$53,310.05 $53,310.05 



QUESTIONS ON THE CHAPTER 

(a) What is an adjustment entry? 

(b) Why are adjustments required? 
Explain how a physical inventory is taken. 
Differentiate between the " Old " and " New " inventories. 
List and briefly describe the eight steps in the bookkeeping or 

accounting cycle. 

5. What is the purpose of the accountant's work sheet? 

6. Give a brief description of the work sheet. 

7. Explain in a series of steps how each pair of columns functions. 

8. (a) Should the debit column exceed the credit column in the 
Profit and Loss group, what will be the result, a profit or a loss? 



2. 

3- 
4- 



1 66 FUNDAMENTALS OF ACCOUNTING 

(b) If this condition exists, then which column should be 
greater in the Balance Sheet group? 

9. Explain how the profit and loss statement may be drawn from 
the completed work sheet. 

10. Explain the preparation of a balance sheet from a completed 
work sheet. 

n. What are closing entries? 

12. Explain closing the books by 3 journal entries. 

13. What is an After Closing Trial Balance? 



PROBLEM MATERIAL 

PROBLEM i 

The following trial balance was taken from the books of G. Evans 
at December 31, 19 . 

G. EVANS TRIAL BALANCE 

As of December 31, 19 

Cash $ 3,240.60 

Accounts Receivable 16,090.54 

Notes Receivable 3,600.00 

Inventory Jan. i, 19 24,820.00 

Notes Payable 4,400.00 

Interest Expense 240.00 

Interest Earned 186.00 

Purchases 62,971.60 

Sales 92,990.00 

Purchase Returns & Allowances .... 845.00 

Sales Returns & Allowances 263.00 

Rent 1,200.00 

Insurance 840.00 

Advertising 2,400.00 

Salesmen's Salaries 6,000.00 

General Office Salaries 8,000.00 

Office Equipment 410.00 

Accounts Payable 18,964.00 

General Expense 1 24.46 

G. Evans, Capital 12,815.20 

$130,200.20 $130,200.20 

Adjustment Data: 

A physical inventory of the merchandise was taken which revealed 
a total of $22,740.00. 

Required: 

( i ) Prepare an accountant's work sheet similar to the form illus- 
trated in Chapter X. 



ACCOUNTING END OF PERIOD 167 

(2) From the completed work sheet prepare a profit and loss state- 
ment, and a balance sheet. 

(3) Write the journal entries necessary to adjust and close the 
books. 



PROBLEM 2 

The following trial balance was taken from the books of W. C. 
Hogan at December 31, 19 . 

W. C. HOGAN TRIAL BALANCE 

As of December 31, 19 . 

1. Accounts Payable $ 20,579.00 

2. Accounts Receivable $ 35,450.00 

3. Advertising 1,623.00 

4. Buildings 70,000.00 

5- Cash 23,585.00 

6. Delivery Equipment 10,000.00 

7. Salesmen's Salaries 13,090.00 

8. Insurance Expense i ,065.00 

9. Interest Earned 1,185.00 

10. Interest Expense 3,844.00 

11. Land 33,000.00 

12. W. C. Hogan Capital 150,000.00 

13. Merchandise Inventory Jan. i . . 65,770.00 

14. Machinery & Equipment 21,350.00 

15. Mortgage Payable 50,000.00 

1 6. Notes Payable 60,000.00 

17. Notes Receivable 14,270.00 

18. Purchases 211,600.00 

19. Sales 242,961.00 

20. Taxes i ,53Q-o 

21. General Office Salaries 18,548.00 



$524,725.00 $524,725^00 



Adjustment Data: 

An inventory has been taken which amounts to $84,610.00. 

Required: 

1 i ) Prepare an accountant's work sheet similar to the form illus- 
trated in Chapter X. 

(2 ) From the completed work sheet prepare a profit and loss state- 
ment and a balance sheet. 

(3) Write the journal entries necessary to adjust and close the 
books. 



CHAPTER XI 

ACCOUNTING AT THE END OF THE FISCAL 
PERIOD (Continued) 

ADJUSTMENTS FOR DEPRECIATION, DEPLETION AND 
BAD DEBTS 

In the last chapter a brief description of the work done at 
the close of the accounting period was presented. At that time 
the only adjustments studied were the entries necessary to ad- 
just the inventory account, particularly, for the New Inventory. 
Now it is our purpose to present further adjustments required 
at the end of the fiscal period. These adjustments are to be pre- 
sented rather thoroughly, with as much detail as is necessary to 
give the student a good idea of the need for the particular ad- 
justment, the purpose served by the adjustment, and the me- 
chanics required for each adjustment, together with ample 
illustrative material. 

DEPRECIATION: WHAT IT is AND FACTORS CAUSING IT 

One real difference between an expense and an asset is the 
rapidity with which the item will be consumed in the operation 
of the business. The account Fuel, is considered an expense 
because it is consumed in operation almost immediately, just as 
an expenditure for electric power would be. An auto truck, on 
the other hand, is considered an asset because it has a relatively 
longer life. It is consumed in the operation of the business, 
however, just as surely as is the fuel which drives the machin- 
ery. The only difference is that the truck may last five years 
as against practically immediate consumption of fuel, coal, oil, 
gas, or electricity. 

The price paid for the auto truck is in reality an expenditure 
made for transportation service rather than for a physical ob- 
ject. Similarly, every dollar spent for a machine or any other 
piece of plant equipment is an outlay for service expected from 
the machine. Each piece of machinery will have a definite serv- 
ice capacity and every operation performed by the machine will 
reduce the life of that machine. 

168 



ACCOUNTING END OF PERIOD 169 

Wear and tear is one of the principal factors of depreciation, 
particularly for an asset in continual operation. Wear and tear, 
however, usually measures the maximum life which may be ex- 
pected from a fixed asset. Deterioration, rust, and rot may 
cause severe damage to property, therefore the action of the 
elements may be a very important factor in shortening the ex- 
pected life. Accidents and sabotage are also factors affecting 
the life of assets, but these factors are unusual and are not ordi- 
narily considered when depreciation calculations are made. 
Obsolescence is another factor, and sometimes a most important 
one in shortening the expected life of fixed assets. A machine 
which has an expected life of ten years may have to be replaced 
long before this period has elapsed because another similar ma- 
chine has been invented and made available which will double 
the capacity of the old machine. It may therefore be uneco- 
nomical to continue the old machine, and its replacement will 
not be due to wear and tear or to the action of the elements, but 
rather to obsolescence. Obsolescence, accidental damage, and 
sabotage factors in reducing the ordinary expected life of a fixed 
asset are usually disregarded when calculating depreciation. 

DEPRECIATION DEFINED 

Depreciation may be briefly defined as the gradual reduction 
in value which takes place in fixed assets, due usually to wear 
and tear and the action of the elements. These combined fac- 
tors tend to reduce the service capacity of the asset and the 
amount of this reduction is spoken of in accounting as depre- 
ciation. 

PURPOSES OF ACCOUNTING FOR DEPRECIATION 

In the last chapter it was stated that adjustment entries were 
required so that the books might reflect the true financial con- 
dition of the organization. In keeping with this purpose it will 
be necessary for every business owning fixed assets properly to 
account for depreciation. One good reason for accounting for 
depreciation is that the cost of the fixed asset may be spread 
evenly over the periods benefiting by the use of the fixed asset, 
until finally the total cost of the asset has been charged to opera- 
tions. Another reason for keeping accounting records for 



170 FUNDAMENTALS OF ACCOUNTING 

depreciation is that the reader of a balance sheet may see that 
depreciation has been provided for and that the fixed assets are 
exhibited at their depreciated values. 



ACCOUNTING FOR DEPRECIATION 

In order that the balance sheet may properly display the 
original cost of a fixed asset and at the same time exhibit the 
depreciated values, it will be necessary to maintain two accounts 
for each fixed asset. In one account all the facts regarding cost 
of the fixed assets will be gathered, such as the invoice price, 
express and cartage necessary to get the asset, and any inci- 
dental costs required to put the machine in full operating con- 
dition. 

A second account which must be maintained for balance sheet 
purposes is most widely known in accounting parlance as a 
Reserve for Depreciation. Thus it is that we maintain, beside 
the fixed asset accounts such as Machinery and Equipment, 
Delivery Equipment, companion reserve accounts, as Reserve 
for Depreciation of Machinery and Reserve for Depreciation 
of Delivery Equipment. Kach asset subject to depreciation is 
therefore represented on the balance sheet by two accounts. 

In the Profit and Loss statement it will be equally important 
that the expense of depreciation be listed together with all other 
expenses of operation. This expense is usually recorded in de- 
preciation accounts, such as Depreciation of Machinery, De- 
preciation of Delivery Equipment, and so forth. 

BASES FOR COMPUTING DEPRECIATION 

Many bases for computing depreciation have been and are in 
use today. Kach method has the same general purpose, to ap- 
portion the cost of service received over the economic life of the 
asset being depreciated. The cost of this service is the dif- 
ference between the original cost less any recovery made from 
the final disposal of the asset, 4k scrap value " or ik turn in value." 
In the case of automobiles and certain machines, u turned in " 
before all their usable life has been consumed in operations of 
the business, this residual value is important and must be ac- 
counted for. On the other hand, with most other fixed assets, 
because it is so difficult to estimate the probable scrap value to 



ACCOUNTING END OF PERIOD 171 

be received at the time of retirement of the fixed asset, and 
because the amount is usually very small and the costs of de- 
molishing or removal often will equal the scrap value, this 
amount is disregarded in actual practice. 

STRAIGHT LINE METHOD 

Probably without a doubt the most widely used method of de- 
termining the periodic depreciation in use today is the so-called 
straight line method. This is the most simple and most easily 
used method. It spreads the cost of depreciation equally over 
each accounting period. The calculation in brief takes the total 
depreciation, which is the cost of the asset less any residual 
value as described before, and divides this amount equally by 
the time length of the accounting period. Thus, for example, 
let us assume, an auto truck cost a contractor $3500.00 de- 
livered and ready for service, and after a three-year life the 
truck is estimated to have a turn-in value of $500.00. The total 
depreciation would be $3000.00, and the annual depreciation 
would be $1000.00. 

In formula this would be: 

Cost turn-in or scrap value 4 . . . . 

-.- - . '---== Annual depreciation cost. 

Life in years 

And applied to our illustrative case: 

$1500.00 $500.00 

- ------ - = .> i ooo. oo per year. 

3 yrs. 

If depreciation for one month is desired it will be necessary 
only to divide the annual amount by twelve. 

OTHER BASES FOR COMPUTING DEPRECIATION 

Perhaps the most theoretically sound basis of computing de- 
preciation is a charge based on production. Under this method 
a machine's productive capacity must be calculated or esti- 
mated in units of production as so many yards, tons, stampings, 
or other convenient measurements which it is expected the ma- 
chine will yield during its economic life. The total depreciation 
(cost minus scrap value ) is then used as the numerator and the 



172 FUNDAMENTALS OF ACCOUNTING 

number of units as the denominator. The result will be the unit 
cost of depreciation. In formula 

Cost scrap value T . .. . r , 

- -- TT . = unit cost of depreciation. 

units v 

For example, let us suppose that a machine cost $650.00 and has 
an estimated scrap value of $50.00, and that in its life it is esti- 
mated the machine will turn out 6,000,000 units; then the per 
unit cost will be $.0001 or ten cents per thousand units pro- 
duced. 

This method will work satisfactorily where production is uni- 
form; but, in practice, with the unevenness of the business cycle, 
and the loss in service capacity which goes on during idle periods 
(which often is greater than in periods of service), and other 
similar difficulties, this method is not widely used. 

There are other methods used to apportion the cost of de- 
preciation, and a great deal more could be said regarding the 
theory of depreciation, but this subject is rightfully reserved 
for a more advanced text. 

The only problem which concerns us, at present, is that each 
period should be charged with a share of the total depreciation 
of all assets which are subject to depreciation, because we wish 
every financial statement to reflect the true financial condition 
of the business. This can be done only if all costs are included 
in our statements. 

CASK FOR DEPRECIATION: STRAIGHT LINE METHOD 

Suppose a contractor purchased a truck in January of 1938 
for $3500.00, which after a three-year life would have an esti- 
mated turn-in value of $500.00. The total depreciation under 
these circumstances would be $3000.00. 

At December 3ist, 1938, the end of the first year, an adjust- 
ing journal entry would be written debiting Depreciation of 
Auto Truck and crediting Reserve for Depreciation of Auto 
Truck accounts in amount of $1000.00, the annual depreciation. 
The Depreciation account, an expense, would be closed at the 
same time, together with all other expense accounts, to the Profit 
and Loss Summary account. The same procedure would be fol- 
lowed at the close of 1939 and 1940 with the following result in 
the ledger: 



ACCOUNTING END OF PERIOD 173 



DEPRECIATION OF AUTO TRUCK 



1938 Adjustment $1000.00' io^S Closed to P. & L. $100000 

1939 Adjustment 100000 j 1030 Closed to P. & L. 100000 

1940 Adjustment 1000 oo 1940 Closed to P. & L. 100000 



RESERVE FOR DEPRECIATION OF AUTO TRUCK 



$100000 

1039 1000.00 

1000.00 



It will be noted that the Profit and Loss Summary account ab- 
sorbed the estimated depreciation annually, while at the same 
time the Reserve account was built up to $3000.00. 

The asset account Auto Truck has, all the while, had a debit 
balance of $3500.00. The net effect of the adjustment has been 
to apportion the loss due to wear and tear to the three years 
which enjoyed the use of the truck. 

Continuing our example, suppose that in 1941 another truck 
is purchased for $2800.00, and that we pay $1000.00 in cash, 
give a series of notes totaling $1300.00, and are allowed $500.00 
for the old truck. The following journal entries should be 
written: 

Auto Truck $2800.00 

Cash $1000.00 

Notes Payable 1300.00 

Auto Truck 500.00 

To record purchase of new truck - allowance 

on old truck $500.00 cash $1000.00. 

notes $1300.00. 



Reserve for Depreciation of Auto Truck .... $3000.00 

Auto Truck $3000.00 

To close the reserve account to Auto Truck ac- 
count. 

To complete our case let us see the effect of these entries on 
the asset and reserve accounts. 



174 FUNDAMENTALS OF ACCOUNTING 

AUTO TRUCK 



1938 


$3500.00 


1941 Allowance 


$ 500.00 


1041 


2800.00 


1941 Reserve 


3000.00 



RESERVE FOR DEPRECIATION OF AUTO TRUCK 



Jan. Dec. 

1941 Closed to j 10.38 $1000.00 

Auto Truck $3000.00 | ig.jg 1000.00 

i 1 940 i ooo oo 

$3000.00 $3000 oo 



It will be observed that maintaining the reserve account 
spreads the depreciation loss over the life of the asset. 

REPLACEMENT OF ASSETS: INSUFFICIENT DEPRECIATION 

The question often arises as to what happens if an asset has 
to be replaced at a figure less than its depreciated book value. 
The easiest way to answer this question is to illustrate with a 
typical case. 

Let us assume that, among its trucks, the American Trucking 
Company Inc. had truck No. 5 which was purchased in January 
of 1937 for $3600.00. The truck was expected to give four 
years of service, after which it would be turned in for an esti- 
mated allowance of $400.00 toward a replacement truck. For 
three years a depreciation reserve account has been maintained 
with an annual credit of $800.00 and now has a total credit bal- 
ance of $2400.00. On June 30, 1940, the truck has to be re- 
placed, and the best allowance toward the purchase of a new 
truck is $550.00. 

Under these circumstances the following entries may be 
written: 

-i- 

Depreciation of trucks 400.00 

Reserve for Depreciation of Trucks 400.00 

To charge the current period with one-half 
year depreciation. 



ACCOUNTING END OF PERIOD 



-2- 

Reserved for Depreciation of Trucks 2800.00 

Auto Truck 

To close the reserve balance to the asset ac- 
count. 



2800.00 



At this point it will be evident that the Auto Truck has a 
present book value of $800.00 (cost $3600.00 less depreciation 
to date of $2800.00). As the truck was traded for only $550.00, 
there is a loss of $250.00 on the transaction. This loss may not 
be taken as a deduction on the income tax return, but will have 
to be closed directly to the surplus account of the corporation. 
The following accounts will conclude 1 the illustration. 



AUTO TRUCK No. 5 



Jan. 1937 total cost 



3600 oo 



3000 oo 



June 1040 allowance 
June- 1040 reserve 
June 1940 loss on trade 



2 SO 00 
^000 OO 



RESERVE FOR DEPRECIATION OF AUTO TRUCK 



June 1940 closed to truck 
account 



2X00 oo 
2800.00 



Dec. 1037 i yr dep. 

Dec HH'^ i y r dep. 

Dec igjo, i yr dep. 

June 10,40 -J yr. dcp. 



800 oo 
800 oo 
800.00 
400.00 

2800.00 



June 1940 loss on trade- 
truck No. 5 



SURPLUS 



25000 



CASE OF OVER-DEPRECIATION 

In this connection let us suppose that the American Trucking 
Company Inc., had another similar case and that, when the 
truck is traded at the end of the fourth year, the company's al- 
lowance is $500.00 for the old truck. Under these circum- 
stances, without illustrating the accounts, it will be apparent that 
there has been a gain of $100.00. This gain on the disposal of 



176 FUNDAMENTALS OF ACCOUNTING 

a fixed asset will have to be reported as additional income on 
the income tax return. 



RATES FOR DEPRECIATION AND THEIR DETERMINATION 

The rates of depreciation should be such as will recover the 
cost or other applicable basis less the ultimate salvage value over 
the estimated period of life of the asset. The rate depends 
solely upon the facts in each case as to the probable useful life 
of the property. Consideration must be given to the character 
of the property, its location, surroundings, actual use, extent of 
operations, and effect of repairs. 

Trucks in one business may call for a rate of 50 /, in an- 
other for a rate of 2o/ per annum. A building located near 
an elevated or surface railroad track may depreciate faster 
than one not subject to vibration. Office equipment may last 
twenty years in some cases, and in others be exhausted quickly. 
Thus each taxpayer will have to show the facts necessary to 
prove the rate in his particular case. Due regard must be given 
to upkeep policy. If a company makes a practice of repairing 
its property or machinery or replacing minor parts, it is only 
natural to conclude that depreciation will be slower than if re- 
pairs are neglected. In the textile business, for example, loom 
fixers are continually at work keeping the machinery in running 
order. This gives a company a heavy deduction for repairs, and 
the depreciation rate therefore should be lower than otherwise. 
Property which is second-hand when purchased will require a 
higher rate. 

Example: A building subject to a 2 c c rate (so-year life) may be 
purchased when 30 years old. Its cost should be depreciated at a 
S c ,'t rate based on the remaining 20 years of life. 

CHANGING THE RATE 

The depreciation rate fixed is not unalterable. If it can be 
demonstrated that the probable useful life of the investment is 
shorter or longer than that already determined, the rate ap- 
plicable to future years will be adjusted in the light of such 

* This and the matter on page 177 and the first paragraph on page 178 is 
from: Alexander Federal Tax Course, Alexander Publishing Co. Inc. 



ACCOUNTING END OF PERIOD 177 

evidence. Extra rates of depreciation may be allowed for a 
particular period or year. Thus, if a company operated over- 
time or double time for an extended period, an increase, par- 
ticularly for machinery, may be allowed. An extra rate may be 
allowed if goods, coarser than those originally intended for ma- 
chinery, are being manufactured. An extra rate may be allowed 
if unskilled labor operates machinery for an extended period. 
The facts are determinative in all such cases. 

If the improvements are added to property, they are likewise 
subject to depreciation. If the improvements will expire with 
the original property, they may be depreciated at a greater rate 
than ordinarily allowed. If an expensive rubber roller is added 
to a bleaching machine, and it will be of no use alter the ma- 
chine is exhausted through wear and tear, it should be depre- 
ciated over the balance of the useful life of the bleaching 
machine. -However, a taxpayer is not permitted under the law 
to take advantage in later years of an earlier failure to claim 
a depreciation allowance or his action in taking an allowance 
plainly inadequate under the known facts in prior years. 

Example: A building with a reasonable estimated life of 33 J years is 
depreciated at a rate of 2 c f \ for 20 years. The owner, claiming a 3'' 
rate as the proper one at the end of the 2o-year period, will be allowed 
a s'/f rate for the remaining 13! years of the building's estimated 
life. The balance for prior years not deducted may not be spread over 
the remaining years as an extra allowance. 

Until 1934 the burden of proof as to unreasonableness of 
depreciation deduction was on the Government. Since that 
year, however, the burden has been on the taxpayer. 

The Treasury Department has issued two different schedules, 
one of five columns and another of fourteen columns, calling for 
certain data, the information requested therein being self- 
explanatory. For those interested, these schedules should be 
obtained from the Treasury Department and studied. They 
call briefly for the following: cost, or other basis, proof of esti- 
mated useful future life, segregation of similar assets having the 
same average life, list of charges against reserves, repair, re- 
newal or upkeep policy, list of losses of discarded items, and 
unusual charges due to casualty, obsolescence, or sale of sub- 
stantial amounts of depreciable property. 



178 FUNDAMENTALS OF ACCOUNTING 



REPLACEMENT 

Amounts expended for replacements or renewals of a per- 
manent nature should be charged directly to the property ac- 
count, or if a reserve for depreciation is maintained in the books, 
the amounts should be charged to such reserve. What consti- 
tutes a replacement is not capable of categorical definition. 
Good accounting practice should be followed. In general, how- 
ever, it refers to larger changes which are made occasionally as 
opposed to incidental repairs which are made regularly, do not 
appreciably prolong the life of the property, and are deductible 
as business expense. The relining of blast furnaces has been 
held a replacement properly chargeable against the depreciation 
reserve, whereas the substitution of a valve or a piece of pipe 
would constitute an incidental repair. 

DEPRIVATION RESERVES ON THE BALANCE SHEET 

Depreciation Reserve accounts are evaluation accounts, as 
explained before. They are created and added to periodically 
to measure the accumulated depreciation which has taken place 
in the fixed asset. The accumulated amount in the Reserve ac- 
count subtracted from the cost of the asset should exhibit the 
depreciated value of the asset. Reserve accounts have credit 
balances, but are neither liabilities not true net worth accounts. 
They are really asset offset accounts, and for classification 
should be shown as parts of the assets they offset. It is a good 
practice, and in conformity with sound theory to show these 
valuation accounts on the balance sheet as deductions from the 
accounts for which they were created, thus: 

Delivery Equipment $17,000.00 

Less: Reserve for depreciation . 6.000.00 

$11,000.00 

DEPLETION 

Depreciation and depletion are quite closely related. Deple- 
tion may be briefly defined as the gradual reduction in value of a 
(natural resource due to the extraction or use of its product. 
Some organizations have assets belonging to the family of nat- 
ural resources such as coal mines, oil wells, stone quarries, metal 



ACCOUNTING END OF PERIOD 179 

mines, clay banks, or timber lands. These fixed assets are sub- 
ject to depletion and in accounting are frequently referred to as 
wasting assets. Companies organized to work with assets of 
this character should make proper provision for the replace- 
ment of the asset when it becomes exhausted. 

The cost of depletion should be absorbed in current opera- 
tions, just as much as depreciation, salaries, or any other ex- 
pense. If this cost be ignored, costs will be understated and 
profits incorrectly reported; with the result that net worth will 
be overstated. Mines, oil wells, and timber lands are pur- 
chased on the basis of the value of their ultimate yield in coal, 
ore, oil, or lumber, and as each ton of coal or mineral, or board 
foot of lumber, or barrel of crude oil is taken from the property, 
its ultimate value is lessened. Depletion is a very important 
problem of exhaustive industries. 

ADJUSTMENT ENTRIES FOR DEPLETION 

The problem of calculating the proper amount which should 
be charged to each period depends upon and varies with the 
industry. Each extractive industry, or manufacturing industry 
utilizing the product of a natural resource will have to work out 
its own problem. Regardless of the difficulties of computing 
the correct amount, the important point to observe is that de- 
pletion be included in the costs. 

The treatment of depletion varies so much with the different 
industries that only the principles involved in recording allow- 
ance for depletion will be illustrated for one industry. 

DEPLETION OF TIMBER LANDS 

Just as the removal of a ton of coal or ore reduces by so much 
the value of a mine, so the cutting of each thousand board feet 
of lumber depletes the value of the timber land. It should be 
quite obvious that some method of writing off the cost of tim- 
ber lands should be adopted. Quite frequently stumped or 
cut-over land has little or no value; therefore, the entire cost 
of the property will often be charged to production, and to each 
thousand feet of lumber must be added so many cents for de- 
pletion expense. 

Each industry must calculate for itself what this proper charge 



i8o FUNDAMENTALS OF ACCOUNTING 

shall be, and production costs must bear this expense. Each 
industry will employ engineers who can furnish the accountant 
the information required for accurately computing this cost. 
The Treasury Department, which employs its own engineers 
for this purpose, will allow or disallow such deductions when 
taken on income tax returns, depending upon the reasonableness 
of the charge. 

ADJUSTMENT FOR ESTIMATED LOSS ON BAD DEBTS 

There is probably no business organization today that can 
boast of one hundred per cent collection of its accounts receiv- 
able. There are many organizations which maintain extensive 
credit departments, and attempt to keep down their credit losses 
by adopting very stiff credit policies, but even these organiza- 
tions cannot prevent some loss from bad debts. This loss can 
be estimated from past experience, and adequate provision for 
doubtful accounts should be made. 

In a long established business having fairly consistent sales 
the loss may be measured in terms of a certain percentage of 
sales. This method is in use in actual practice, but a more 
reliable method of calculating the probable loss on bad debts 
is one based on the accounts themselves. By use of this method 
the accountant u ages " each account. A form is prepared on 
which each balance is classed as column No. i " accounts not yet 
due/ 7 column No. 2 " accounts 30 to 60 days/ 7 column 3 " ac- 
counts 6 1 to 90 days/' column 4 u accounts 3 to 6 months old," 
or column 5 " accounts 6 months to i year. Then follows a sixth, 
and usually last, money column for " old accounts." Into this 
column will be entered all old accounts and directly following 
will be a space provided for a comments." In this latter space 
some comment will be written for each old account. An experi- 
enced accountant familiar with his client's collection policy and 
past experience with each group of accounts can readily set rates 
for the several columns. When these rates have been applied 
to the totals of each column and the results added, the total 
amount of the probable loss will be available. When this amount 
is known, the then existing reserve may be deducted and the 
difference will measure the loss chargeable to the current period. 
This method is more reliable than basing the probable expense 
on sales, because current conditions may change and abnormal 



ACCOUNTING END OF PERIOD 181 

conditions, such as follow after a war, or a depression period 
make the evaluation of the accounts themselves a more re- 
liable basis. 

In problem work it is not feasible to ask the beginning stu- 
dent to u age " accounts in order to arrive at the proper allow- 
ance for doubtful accounts; therefore, in all problem material, 
an arbitrary percentage of accounts receivable shall be stated, 
as " Provide 2 c /c of accounts receivable, for doubtful accounts/' 

JOURNAL ENTRY FOR DOUBTFUL ACCOUNTS 

When the amount to be set up as a reserve or the current ad- 
dition to the reserve has been calculated as described above, the 
following adjusting journal entry should be written. 

Bad Debt Expense ? 

Reserve for Doubtful Accounts ... ? 

To charge the current period with the 
probable loss on bad debts. 

If this entry has established a new reserve account, then each 
subsequent entry will be made to increase the reserve. If the 
reserve has been established then the above entry would simply 
add the current addition to the reserve. 

FUNCTION OF THE RESERVE ACCOUNT 

As accounts are determined to be worthless they should be 
charged against the reserve and the customer's account closed, 
as in the following journal entry. 

Reserve for Doubtful Accounts $60.00 

John H. Smith $60.00 

To close account with John H. Smith. 
Customer is bankrupt. 

This entry will reduce the amount of the reserve and, should 
the bad debt losses actually go beyond the amount of the re- 
serve, then, of course, the reserve has been inadequate and sub- 
sequent charges will have to be more liberal. On the other 
hand, there is no use allowing this reserve to be built up out of 
all proportion to the actual accounts being evaluated. As a 
matter of fact, the federal income tax officials would soon check 
up on that situation, because they permit only a " reasonable 
allowance " for bad debts, as for depreciation. 



1 82 FUNDAMENTALS OF ACCOUNTING 



SUMMARY ILLUSTRATION 

In the next chapter further adjustments for accrued and de- 
ferred items are studied, after which a complete case illustrating 
adjusting and closing the books is presented. The illustration 
includes an improved and usable Accountants' Work Sheet, 
which the student may find helpful in solving the problems of 
this chapter. 



QUESTIONS OX THE CHAPTER 

1. What is depreciation? 

2. Define obsolescence. 

3. How is depreciation calculated? Give an example. 

4. Explain the difference between increasing a reserve and creating 
a reserve. 

5. Explain depletion. 

6. Is depreciation an expense? 

7. What do you understand by Reserve jor Doubtful Accounts? 

8. Explain aging accounts. 

9. (a) Write the journal entry required to set up a Reserve for 
Doubtful Accounts, amount $1000.00. 

(l>) Presume one account " Mr. H. Smith " has been declared 
worthless in the amount of $200.00. Write the journal entry to charge 
it off. 

10. Why are reserves for obsolescence usually not set up? 



ACCOUNTING END OF PERIOD 
PROBLEM MATERIAL 

PROBLEM i 

The following trial balance was taken from the books of Mr. R. 
Holmes as of November 30. 





TRIAL BALANCE Nov 


. 30, 19 


I. 


Cash 


$ 3,846.18 


2. 


Notes Receivable 


2.400.00 


3- 


Accounts Receivable 


36.420.19 


4- 


Reserve for Doubtful Accounts . 




5- 


Land 


3.00000 


6. 


Buildings 


26.000.00 


7- 


Reserve for Dep. of Bldgs 




8. 


Notes Payable 




9- 


Accounts Payable 




10. 


Purchases 


85.960.75 


1 1. 


Sales 




12. 


Purchase Returns 




13- 


Sales Returns 


726.40 


*4- 


Rental Income 




I V 


Taxes 


320.00 


16. 


Advertising 


i .600 oo 


17- 


Insurance 


240 oo 


18. 


Salesmen's Salaries 


4.500 oo 


19. 


Automobile Equipt 


4,200.00 


20. 


Res. for Dep. of Auto Equipt. . . 




21. 


General Office Salaries 


2.600.00 


2 2 


Inventory Mav 31 


16,428.60 


23- 


Mortgage Payable 




24- 


Interest Expense 


324.00 


25- 


Interest Income 




26. 


R. Holmes Capital 




27. 


Travel Expense 


1,264.00 


28. 


General Expense 


4 1 8 60 


29. 


Machinery 


1,200.00 






$191,448.72 



$ 312.40 



2,860.00 

4,000.00 

22,480.72 

102,840.60 
418.00 

600.00 



840.00 



IO,OOO.OO 

38.60 
47,058.40 



$191,448.72 

Adjustment Data: 

1. The Merchandise Inventory at November 30 is valued at 
$18,240.72. 

2. Add i c /f- of the Accounts Receivable to the Reserve for Doubt- 
ful Accounts. 

3. The annual allowance for depreciation of Buildings is 2%. 
Provide for the current period. 

4. The depreciation allowance for the Automobile Equipment is 
calculated to be $540.00 for the current period. 

5. The Machinery was purchased June ist and it is estimated that 
the turn-in value will be $200.00 after a 5-year life. Provide 
proper depreciation for the period. 



184 



FUNDAMENTALS OF ACCOUNTING 



Required: 

1 i ) Given the above trial balance and adjustment data, prepare an 
accountant's work sheet. (Use form illustrated in Chapter 
XII.) 

( 2 ) From the completed work sheet prepare a profit and loss state- 
ment, and a balance sheet. 

(3) Write the journal entries necessary to adjust and close the 
books. 

PROBLEM 2 

The following trial balance was taken from the books of Mr. J. 
Brynes, at June 30, 19 . 

Sales $424,418.60 

Return Sales & Allowances $ 1,416.00 

Purchases 382,965.00 

Return Purchases & Allowances .... 1,872.45 

Cash 17,910.82 

Accounts Receivable 184,317.19 

Reserve for Doubtful Accounts .... 2,416.06 

Notes Receivable 3,600.00 

Land 7,000.00 

Buildings 80,000.00 

Machinery & Equipment 64,000.00 

Office Equipment 2,400.00 

Reserve for Dep. of Buildings 26,800.00 

Reserve for Dep. of Mach. & Equipt. 16,400.00 

Reserve for Dep. of Office Equipt. . . 720.00 

Inventory Jan. i 40,412.84 

Taxes 3,600.00 

Rental Income 1,200.00 

Interest Expense 1,286.40 

Interest Income 1 29.00 

Mortgages Payable 140,000.00 

Notes Payable 26,400.00 

Advertising 6,000.00 

Salesmen's Salaries 6,000.00 

Accounts Payable 112,210.90 

J. Brynes Capital 58,342.48 

J. Brynes Drawings 1,200.00 

General Expense 121.24 

General Office Salaries 8,480.00 

Petty Cash Fund _??9;O 

$810,909.49 $810,909.49 



Adjustment Data: 

1. The Merchandise Inventory is valued at $32,816.00. 

2. One account is worthless, the company is bankrupt, and Mr. 
Brynes agrees to it being charged off, to the amount of $610.00. 

3. Your study of the Accounts Receivable indicates that a reserve 
of $2410.00 will be required. Increase the reserve accordingly. 



ACCOUNTING END OF PERIOD 185 

4. Increase the Reserve for Depreciation of Buildings i 

5. Increase the Reserve for Depreciation of Machinery j 

6. Increase the Reserve for Depreciation of Office Equipment 
$60.00. 

Required: 

1 i ) An accountant's work sheet. 

(2) A profit and loss statement and a balance sheet. 

PROBLEM $ 

(a) Mr. Jacobs has Accounts Receivable of $20,600.00 and a Reserve 
for Doubtful Accounts of $i 100.00. He has just been informed 
that an account in the amount of $600.00 is worthless, and in- 
structs you to write it off. You are then to write an adjustment 
which will bring the Reserve for Doubtful Accounts up to 5'^ 
of the balance of Accounts Receivable. 

Required: The journal entries required to close the account and adjust 
the reserve. 

(b) AUTO TRUCK 



Jan. 1937 4500.00 



RESERVE FOR DEPRECIATION OF AUTO TRUCK 



Dec. 1937 looo.oo 

Dec. 1038 looo.oo 

Dec. 1939 looo.oo 



The two accounts above appear on the books of the Troy Machine 
Co. At January, 1940, the Troy Machine Company buys a new 
truck, which is to replace the old one. The cost of the new truck is 
$3600.00. The Champion Truck Co. will allow the Troy Machine 
Co. $800.00 for the old truck and accept a check for $1300.00 and 
finance notes for the balance. 

Required: 

1 i ) The journal entry for the purchase of the new truck. 

(2) The journal entry or entries to clear the old truck from the 
books. 

(3) Rule the Asset and Reserve accounts and post the journal 
entries. 



1 86 FUNDAMENTALS OF ACCOUNTING 

PROBLEM 4 

The Monroe Machine Company has just purchased a new machine, 
which cost $4500.00, delivered and installed. The company engineer 
expects the machine to be used regularly day in and day out and to 
last only four years, after which it will be turned in for an agreed al- 
lowance of $500.00. 

(a) Using the straight-line method, set up a schedule of deprecia- 
tion for the new machine. 

(b) Using the units of production method, assuming the machine is 
expected to turn out four million units before being turned in, com- 
pute the rate per thousand units produced. Assume further that, for 
the year just ended, the company has produced 860,000 units. How 
much should be charged for depreciation? 

PROBLEM 5 

Assume that the machine mentioned in Problem 4 has been in serv- 
ice for four years, and using the straight line method of depreciation 
a proper reserve has been accumulated. 

(a) Prepare accounts for the Reserve and Depreciation, showing 
the entries for four years. 

(b) Assume that the Monroe Machine Company at the end of the 
fourth year has an offer to trade in the old machine for a similar new 
machine. The new machine, however, is to cost $5000.00; the seller 
will allow the Monroe Machine Company $750.00 for the old ma- 
chine, accept $3000.00 in finance notes and a check for the balance. 

Write the journal entries required to clear the old machine from 
the books and for the purchase of the new machine. 



CHAPTER XII 

ACCOUNTING AT THE END OF THE FISCAL 
PERIOD (Continued) 

ADJUSTMENTS FOR ACCRUED AND DEFERRED ITEMS 

The last chapter presented adjustments required for depre- 
ciation and doubtful accounts. This chapter continues the 
study of adjustments with a treatment of the adjustments re- 
quired for accrued and deferred items. 

BOOKS KEPT ON THE CASH BASIS 

Books may be kept either on the " cash basis " or on the " ac- 
crual basis." When books are kept in such a way that entries 
for expense and income are made only when cash is actually 
disbursed or received, they are said to be kept on the cash basis. 

If books are kept on a strictly cash basis it will not be possible 
to prepare truly correct financial statements. The only way 
possible for a set of books kept on a strictly cash basis to yield 
true financial statements would be to have all expenses ap- 
plicable to the period paid within the period, and all income 
earned in the period actually received in cash or its equivalent, 
and at the same time to be certain that no income was received 
in advance. Such a system could hardly be found in modern 
business. We must therefore conclude that where books are 
kept on a strict cash basis, any financial statements prepared 
cannot hope to portray the true state of affairs. Just as soon as 
proper adjustments are made; (a) to provide for expenses which 
apply to the current period, but which have not been recorded 
because the cash was not actually disbursed; (b) to bring onto 
the books income earned in the current period, but not recorded 
because the cash was not actually received; (c) to defer to 
future periods the amount expended for expense items which 
will benefit future periods, and (rf) to defer similarly income 
collected in the current period if part of that income rightfully 
belongs to a subsequent period, then the system of account keep- 
ing is said to be on the accrual basis. 

187 



i88 FUNDAMENTALS OF ACCOUNTING 

The accrual basis of acount keeping is not a completely dif- 
ferent system, but rather simply a modification of the records 
by means of certain adjustment entries written at the end of the 
accounting period. These entries are written to bring onto the 
books all income earned in the period, and at the same time by 
proper adjustment record all expense applicable to the period. 



ADJUSTMENTS REQUIRED 

To illustrate why it is necessary to adjust the books, and to 
show how these adjustments should be written, let us now study 
the four types of adjustments usually required. 

GROUP I 

ADJUSTMENTS FOR ACCRUED EXPENSES AND 
CORRESPONDING ACCRUED LIABILITY 

Case No. i 

Suppose that Mr. Phillip Smith keeps his records on the cash 
basis, and at the end of the year has his books closed and state- 
ments prepared by a public accountant; that on the trial bal- 
ance the Salaries and Wages account shows a balance of 
$6472 .00. Upon examination of the account it is found that the 
last amount paid Tuesday, December 29, covered the weekly 
salary to and including, December 26. 

Criticism 

If an adjustment entry is not written, and the books closed in 
their present condition, the year's expenses will be understated 
by the amount earned by the workers from the 28th through the 
3ist, which should be included in the expenses of the current 
period, if true and correct financial statements are desired. 

Adjustment 

From time cards it is determined that there is due the work- 
ers exactly $720.00 for the period in question. The following 
adjustment will add this amount to the Salaries and Wages ac- 
count, and at the same time record the company's liability for 
unpaid wages. 



ACCOUNTING END OF PERIOD 189 

Salaries & Wages $720.00 

Wages Payable $720.00 

To record the accrued wages Dec. 28 to 
3 1 inclusive as an expense and to record 
the corresponding liability for unpaid 
salaries and wages. 

Conclusion 

After this entry has been written and posted, the Salaries and 
Wages account will appear as follows : 



SALARIES & WAGES 



Weekly pay dates, for year 
listed here (with detail of 
weekly pay-rolls omitted to 
save space) but the total ac- 
tually paid would be 
Adjustment: 
Dec. 31 

For Dec. 28-31 
Total wages for year 



$6472.00 



720.00 
$7192.00 



WAGES PAYABLE 



Dec. 31, Adjustment 

Pay Roll Dec. 28-31 $720.00 



The Salaries and Wages account is now ready to be closed, to- 
gether with all other expenses to the Profit and Loss Summary. 



Case No. 2 

Another expense which requires adjustment in a similar man- 
ner is that for interest accrued on notes or mortgages payable. 

Let us assume the company has outstanding a $10,000.00 
Mortgage Payable upon which there is six per cent interest 
payable semi-annually, June ist and December ist. 

Criticism 

Unless the proper adjustment is made, the year's expenses 
will not include the interest expense in amount of $50.00, De- 
cember's share of the interest on the $10,000.00 Mortgage Pay- 



i go 



FUNDAMENTALS OF ACCOUNTING 



able, because the interest for December will not be paid until 
the following June. 

Adjustment 

Interest Expense $50.00 

Interest Accrued on Mortgage Payable $50.00 

To record one month's interest at 6% on 
$10,000.00 Mortgage Payable. 

Conclusion 

When the closing entries are written, the interest expense ac- 
count will be closed to the Profit and Loss Summary and the 
amount will include this accrued interest, together with any 
other interest actually paid. The ledger accounts would then 
appear as follows: 

INTEREST EXPENSE 



Interest paid during year 
Dec. Interest accrued 



$757.00 



_ 
$807.00 



To Profit & Loss Summary $807.00 



$807.00 



INTEREST ACCRUED ON MORTGAGE PAYABLE 



Dec. 31 Adjustment 



GROUP II 

ADJUSTMENTS REQUIRED FOR ACCRUED INCOME 
AND CORRESPONDING ACCRUED ASSETS 

Suppose that the company has on its trial balance an Invest- 
ment account, with a debit balance of $2000.00, and that investi- 
gation of the account shows that the company owns two $1000 
industrial bonds which pay 5% April and October ist of each 
year. The last interest check was recorded October ist. If the 
books were closed without adjustment, the interest accrued from 
October ist to the end of the year would not be included in the 
income for the year, thereby understating income by exactly 
$25.00. 



ACCOUNTING END OF PERIOD 191 



ADJUSTMENT 

GENERAL JOURNAL 

Accrued interest receivable $25.00 

Interest earned $25.00 

To set up the accrued asset and credit the 
interest earned account with 3 months' 
interest earned in the current year. 

Conclusion 

When this entry is posted, the accounts will reflect the true 
financial condition. The year's interest income will include all 
interest earned, and the accrued interest receivable will be set 
up so that it may appear on the yearly balance sheet as an asset 
to be added to the book value of the bond. 

The accounts would look as follows : 

INVESTMENTS 



2 Bonds; interest dates 

April i, Oct. i $2000.00 



INTEREST EARNED 



Cash collected from all sources $i 1 2.00 
Accrued on Bonds 25.00 

$137.00 

ACCRUED INTEREST RECEIVABLE 



Accrued Oct. i to Dec. 31 

$2000 at 5% $ 25.00 



GROUP III 

Deferred Expense Items 

A. Supply Inventories. At the close of the accounting period 
there will often be certain supplies on hand which should be 
inventoried very much the same as merchandise. When supply 
items necessary to carry on the business are purchased, they are 



192 FUNDAMENTALS OF ACCOUNTING 

usually charged directly to expense accounts such as : Office sup- 
plies, Gasoline and Oil, Coal or Fuel, and Postage. At the close 
of the accounting period the cost value of unused supplies should 
be determined and taken away from the expense accounts to 
which they were charged. This is easily accomplished by ad- 
justment entries such as the following: 



GENERAL JOURNAL 

Office Supplies Inventory $ 60.00 

Office Supplies $ 60.00 

To record the asset value of office sup- 
plies on hand and to adjust the expense 
account to its true cost for the period. 

-and- 

Gasoline & Oil Inventory $210.00 

Gasoline & Oil $2 10.00 

To record the asset value of 1000 gals, 
of gasoline @ .14 = $140.00 and mo- 
tor oil on hand $70.00, and to reduce 
the expense accounts accordingly 

After these entries have been written and posted, the ledger 
accounts would look as follows, and the balance of the supply 
accounts would reflect the true expense for the period, while the 
inventory accounts represent assets. 

OFFICE SUPPLIES 



Dec. 31 to date, 

Total Purchases $190.00 



June i Inventory 



adjustment $60.00 



OFFICE SUPPLIES INVENTORY 



June i Adjustment $ 60.00 

B. Case for Prepaid Expenses. Often certain expenses such 
as advertising and insurance will be purchased in amounts which 
will benefit more than the year period. Insurance companies, 
for instance, and their agents will give a good discount if a three- 
year policy is purchased instead of a one-year policy. Similarly, 



ACCOUNTING END OF PERIOD 193 

an advertising agent will quote a very attractive figure and 
allow a big discount if a yearly advertising contract is paid in 
advance instead of taking one payable month by month. 

Suppose a fire insurance policy is renewed November ist for 
three years and a check given for the total premium $360.00. 

If the books were closed without adjustment, the entire 
$360.00 would be included in the year's insurance expense ac- 
count, even though the current year would receive only two 
months' fire insurance protection. 



ADJUSTMENT TO CORRECT 

Prepaid Insurance Premiums $340.00 

Insurance Expense $340.00 

To set up the asset value of prepaid in- 
surance premiums and to reduce the 
year's insurance expense accordingly. 



CASE FOR PREPAID ADVERTISING 

Suppose, similarly, a six months 7 advertising contract were 
signed October ist and a check issued $480.00. At that time 
the entry would be: 

GENERAL JOURNAL 

Advertising $480.00 

Cash $480.00 

Contract for October to March inclu- 
sive 

If the books were closed without adjustment, the current year 
would stand $240.00 in advertising which would, in fact, benefit 
the first three months of the next fiscal year. This, of course, 
is not fair, and so the following adjustment entry should be 
written. 

ADJUSTMENT TO CORRECT 

Prepaid Advertising $240.00 

Advertising $240.00 

To set up the asset value of the unused 
advertising and reduce the advertising 
expense accordingly. 



i 9 4 FUNDAMENTALS OF ACCOUNTING 

GROUP IV 

ADJUSTMENTS FOR! DEFERRED INCOME AND CORRESPONDING 

LIABILITY 

Rental Income and Subscription Income are good examples 
of Income accounts which are often received as payments cover- 
ing more than one period. If the income collected in advance 
will benefit more than one period, because the current period 
should be credited only with its correct share of income, it will 
be necessary to write an adjustment entry which will defer that 
part of the income which belongs to the future and thus permit 
the current period to receive credit only for income earned in 
the period under review. Such an adjustment will place on the 
balance sheet a liability for the amount of Rentals Received in 
Advance or for Subscriptions Received in Advance. 

Deferred Income 
Case No. i 

Suppose Mr. Smith rents out part of his building and collects 
the rents quarterly in advance. A trial balance drawn Decem- 
ber 31, 19 reveals an account Rental Income with a credit 
balance of $1300.00. Upon examination of the account, it is 
learned that on November ist $300.00 was received, being the 
rental for the months of November, December, and January. 
Thus it is seen that, unless an adjustment entry is written, the 
present year's income will be overstated by $100.00 which right- 
fully belongs with the income of the following year. 

Adjustment Entry 

Rental Income $100.00 

Rentals Received in Advance $100.00 

To defer one month (January) rent 
from the current year to the next where 
it rightfully belongs. 

If this entry is written, the rental income will be adjusted to 
$1200.00, the true earnings for the current year. At the same 
time the liability of the company to the tenant will be recorded 
on the balance sheet under the caption, Rentals Received in 
Advance. 



ACCOUNTING END OF PERIOD 



CASE ILLUSTRATION: ADJUSTING AND CLOSING THE BOOKS 

In order the better to visualize the entire procedure of ad- 
justing and closing a set of books, where adjustments are re- 
quired for accrued and deferred items as well as for the new mer- 
chandise inventory, depreciation, and provision for doubtful 
accounts, a complete illustrative problem is now presented. Fol- 
lowing the statement of the problem, a complete demonstration 
solution is presented. 

The following trial balance is taken from the books of the 
Morgan Company: 



TRIAL BALANCE DECEMBER 31, 19 



i. 

2. 

3- 

4- 

5< 
6, 

7- 
8. 

9- 
10. 

n. 

12. 

13- 
14. 

IS- 

16. 

!? 

18. 
19. 

20. 
21. 
22. 

23. 
24. 

25- 
26. 
27. 



Cash 

Notes Receivable 

Accounts Receivable 

Reserve for Doubtful Accounts . . . 

Inventory January 2 

American Can Bonds 6% 

Land 

Buildings 

Machinery 

Equipment & Tools 

Delivery Equipment 

Reserve for Depreciation of Build- 



ings 



Reserve for Depreciation of Ma- 
chinery 

Reserve for Depreciation of Equip- 
ment & Tools 

Notes Payable 

Accounts Payable 

Mortgage Payable 6% 

John Morgan, Capital 

Sales 

Purchases 

Taxes 

Insurance 

Advertising 

Salesmen's Salaries 

General Office Salaries 

Interest Expense 

Interest Income 



6,420 

2,OOO, 
24,180, 

I2,OOO, 

2,OOO, 

6,OOO 

2O,OOO, 

l8,OOO, 

5,400. 

2,6OO, 



,00 
oo 
,00 

,00 

oo 

.00 
,00 

,00 
oo 
,00 



40,000, 

120 

240 

600, 

8,400, 

6,200 

372 



,00 

.00 
.00 

,00 

,00 

.00 
.00 



$ 482.00 



2,000.00 
7,200.00 

860.00 
4,000.00 
16,000.00 
12,000.00 
46,858.00 
65,000.00 



132.00 



$154,532.00 $154,532.00 



196 FUNDAMENTALS OF ACCOUNTING 

It has been determined that adjustments will have to be writ- 
ten for the following: 

1. The New Inventory is valued at $14,500.00. 

2. The Reserve for Doubtful Accounts is to be increased by i% of 
Sales. 

3. Increase the Reserve for Depreciation of Buildings by the annual 
rate of 2%. 

4. Increase the Reserve for Depreciation of Machinery by the annual 
rate 5%. 

5. Increase the Reserve for Depreciation of Equipment and Tools 
$485-00. 

6. Create a Reserve for Depreciation of Delivery Equipment calcu- 
lated to be $500.00. 

7. The insurance has at present an unexpired value of $80.00. 

8. The advertising contract similarly has an unexpired value of 
$120.00. 

9. The semi-annual interest on the mortgage will be payable Janu- 
ary 2 next and it is decided to accrue this expense. 

10. There is also $18.00 to be accrued on the Notes Payable. 

11. The bonds of the American Can Company pay interest regularly, 
3% May ist and November ist, accrue the interest for the bal- 
ance of the year. 

12. It has been calculated from current tax bills that taxes in amount 
of $160.00 should be accrued. 

13. Commission and salaries are due to salesmen in amount of 
$280.00. 

14. Similarly, general office salaries are due in amount of $210.00. 

ACCOUNTING PROCEDURE 

In practice the accounting department usually prepares the 
work sheet first, so that the required financial statements may 
be quickly prepared for use of the management. After this work 
is completed, the accounting department then closes the books 
and prepares them for use in the new year. We shall fol- 
low that procedure now and present first the completed work 
sheet. 

The work sheet on the following page is fundamentally the 
same as that presented in Chapter X. The form has been ex- 
panded to include a set of columns for the adjusted trial bal- 
ance. These columns are used to check the accuracy of the 
work and are helpful to beginning students, particularly when 
there are more than a few adjustment entries. 



ACCOUNTING END OF PERIOD 



197 



EXPLANATION OF THE ADJUSTMENT ENTRIES 

The student will probably get the most from a study of the 
work sheet if he reviews carefully each adjustment entry. With 
this in mind, the fifteen entries necessary to properly adjust the 
books are now written, together with appropriate explanations. 







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2 t 

u 


5 -o 

O O 


o i 

^ 2 
1 5 


^* g i 

^" "3 S 
OT 


I 












SS2SS 


s s ss ss 


s & s 


a g s 


J5SSSS 


335^ 


















^ 











198 



FUNDAMENTALS OF ACCOUNTING 



GENERAL JOURNAL 

-i- 

Inventory Dec. 31, 194- 

Profit & Loss Summary 
To set up the asset value of the new Inventory. 



Profit & Loss Summary 

Inventory January 2, 194- 

To transfer the beginning inventory to the Profit and 
Loss Summary. 

-2- 

Bad Debt Expense 

Reserve for Doubtful Accounts 

To provide the required increase for probable bad debts; 
i% of Sales. 

Depreciation of Buildings 

Reserve for Depreciation of Buildings 
To provide the depreciation for year 2%. 

-4- 
Depreciation of Machinery 

Reserve for Depreciation of Machinery 
To provide the year's depreciation 5%. 

-5- 
Depreciation of Equipment & Tools 

Reserve for Depreciation of Equipment and Tools 
To increase the reserve by the current provision. 

-6- 

Depreciation of Delivery Equipment 

Reserve for Dep. of Del. Equipment 
To create a reserve for depreciation of the delivery equip- 
ment. 

Unexpired Insurance 

Insurance 

To record the asset value of the unexpired insurance and 
to reduce the insurance expense accordingly. 

-8- 
Unexpired Advertising 

Advertising 

To record the asset value of the unexpired advertising 
and to reduce the advertising expense accordingly. 

-9- 
Interest Expense 

Interest Accrued on Mortgage 

To accrue the semi-annual interest 3% on $12,000.00 
$360.00 due Jan. 2 next. 

-10- 

Interest Expense 

Interest accrued on Notes Payable 
To accrue interest to date. 



1 






14,500 


00 










14,500 


oo 


12,000 


00 










12,000 


oo 


650 


00 










650 


oo 


400 


oo 










400 


00 


900 


00 










900 


oo 


485 


00 










485 


oo 


500 


00 










500 


oo 


80 


00 










80 


oo 


120 


oo 










1 20 


oo 










360 


00 










360 


00 


18 


00 










18 


00 



ACCOUNTING END OF PERIOD 



199 



20 


oo 










20 


OO 


1 60 


00 










1 60 


00 


280 


00 










280 


oo 


2IO 


oo 










2IO 


00 



-II- 

Interest Accrued on Bonds 

Interest Income 
To accrue 2 months bond interest. 

~I2- 

Taxes 

Taxes Accrued 
To accrue balance of year's taxes. 



Salesmen's Salaries 

Salesmen's Salaries Accrued 

To add the accrued salaries to the expense account and 
record the corresponding liability. 

-14- 
General Office Salaries 

General Office Salaries Accrued 

To add the accrued salaries to expense and set up the 
corresponding liability. 

The transaction numbers used to designate the adjusting en- 
tries above have been used to designate the respective adjust- 
ments on the work sheet. It will be helpful if the student traces 
each of these entries from the journal to the work sheet. 

After the adjustment entries have been written on the work 
sheet, the first four columns are consolidated into the Adjusted 
Trial Balance; this procedure gives the same result as is obtained 
when the adjusting entries are posted to the ledger. At this 
point the student should find little difficulty in classifying the 
accounts into the last four columns. When this has been done 
and the columns added, a profit of $7957.00 is apparent; the 
assets are greater than the liability and net worth accounts by 
that amount, just as the income accounts total the identical 
amount greater than the total of the expense column. 



THE PROFIT AND LOSS STATEMENT 

At this point it may prove helpful to present a profit and loss 
statement, prepared from the Profit and Loss columns of the 
work sheet. 



200 FUNDAMENTALS OF ACCOUNTING 

THE JOHN MORGAN COMPANY 

Statement of Income, Profit and Loss for the Year Ended 
December 31, 19 

Income from Sales $65,000.00 

Deduct the Cost of Goods Sold: 

Inventory, Jan. 2, 19 $12,000.00 

Add Purchases 40,000.00 

Total Merchandise available for sale .... $52,000.00 

Less Inventory Dec. 31 14,500.00 

Cost of Goods Sold 37,500.00 

Gross Profit on Sales $27,500.00 

Deduct: Expenses of Operation: 
Selling Expense: 

Advertising $ 480.00 

Salesmen's Salaries 8,680.00 

Depr. of Del. Equip 500.00 

$ 9,660.00 
General and Administrative Expense: 

Taxes $ 280.00 

Insurance 160.00 

General Office Salaries . . . 6,410.00 

Bad Debt Expense 650.00 

Depr. of Bldgs 400.00 

Depr. of Machinery 900.00 

Depr. of Equip. & Tools . 485.00 

$ 9,285.00 

Total Operating Expense 18,945.00 

Operating Profit $ 8,555.00 

Deduct the Non-Operating Expense 

Interest Expense $ 750.00 

Less Interest Income 152.00 

Net Non-Operating Expense 598.00 

Net Profit for the Period $ 7,957.00 



BALANCE SHEET 

The following balance sheet is prepared from the Balance 
Sheet columns of the work sheet. The preparation of the bal- 
ance sheet from the completed work sheet may be easily under- 
stood, by tracing each amount in the Balance Sheet columns to 
the balance sheet below. 



ACCOUNTING END OF PERIOD 



2OI 



THE JOHN MORGAN COMPANY 
Balance Sheet as of December 31, 19 

ASSETS 

Current Assets: 

Cash $ 6,420.00 

Notes Receivable 2,000.00 

Accounts Receivable $24,180.00 

Less Reserve for Bad Debts 1,132.00 23,048.00 

Merchandise Inventory Dec. 31 14,500.00 

American Can Bonds 2,000.00 

Add Accrued Interest 20.00 2,020.00 

Total Current Assets $47,988.00 

Fixed Assets: 

Land 6,000.00 

Buildings 20,000.00 

Less Reserve for Depr. . . 2,400.00 17,600.00 

Machinery 18,000.00 

Less Reserve for Depr. . . 8,100.00 9,900.00 

Equipment and Tools .... 5,400.00 

Less Reserve for Depr. . . 1,345.00 4,055.00 

Delivery Equipment 2,600.00 

Less Reserve for Depr. . . 500.00 2,100.00 

Total Fixed Assets 39.655.00 

Deferred Charges: 

Unexpired Insurance 80.00 

Unexpired Advertising .... 120.00 200.00 

Total Assets $87,843.00 

LIABILITIES AND NET WORTH 

Current Liabilities: 

Notes Payable 4,000.00 

Accrued Interest 18.00 4,018.00 

Accounts Payable 16,000.00 

Mortgage Interest Accrued 360.00 

Taxes Accrued 160.00 

Salesmen's Salaries Accrued 280.00 

General Office Salaries Accrued 210.00 

Total Current Liabilities 21,028.00 

Fixed Liabilities: 

Mortgage Payable 12,000.00 

Total Liabilities 33,028.00 



202 FUNDAMENTALS OF ACCOUNTING 

Net Worth: 

John Morgan, Capital Jan. 2 $46,858.00 

Add Profit for Year 7,957.00 

Capital Dec. 31 $54,815.00 

Total Liabilities and Net Worth $87,843.00 



CLOSING ENTRIES 

To continue the accounting work usually done at the end of 
the period, we next present the Journal entries required to close 
the books. As in the previous illustration the books are closed 
by means of three Journal entries. 



GENERAL JOURNAL 

i 

Sales $65,000.00 

Interest Income 152.00 

Profit and Loss Summary $65,152.00 

To transfer the income account balances 
to the P. & L. Summary and close the in- 
come accounts 

-2- 

Profit and Loss Summary 59,695.00 

Purchases 40,000.00 

Taxes 280.00 

Insurance 160.00 

Advertising 480.00 

Salesmen's Salaries 8,680.00 

General Office Salaries 6,410.00 

Interest Expense 750.00 

Bad Debt Expense 650.00 

Depreciation of Machinery 900.00 

Depreciation of Buildings 400.00 

Depreciation of Equipment and Tools . 485.00 

Depreciation of Delivery Equipment . . 500.00 

To close sundry expense accounts to the 

Profit and Loss Summary 

-3- 

Profit and Loss Summary 7>957oo 

John Morgan Capital 7>957*o 

To transfer the net profit to the proprie- 
tors Capital account and close the P. & L. 
Summary account 



ACCOUNTING END OF PERIOD 



203 



GENERAL LEDGER 



The next step usually at this point is to post the adjusting and 
closing entries to the Ledger. 



CASH 



Balance 



6,420.00 



NOTES RECEIVABLE 



Balance 



2,000.00 



ACCOUNTS RECEIVABLE 



Balance 



24,180.00 



RESERVE FOR DOUBTFUL ACCOUNTS 



Balance 482.00 

Adjustment (2) 650.00 

December 31, Balance ITi 33.00 



INVENTORY 



Balance Jan. 
Adjustment (i) 



12,000.00 
14,500.00 



Adj. (i A) to P. & L. 



12,000.00 



AMERICAN CAN COMPANY BONDS 6% 



Balance 



2,000.00 



LAND 



Balance 



6,000.00 



BUILDINGS 



Balance 



20.000.00 



204 FUNDAMENTALS OF ACCOUNTING 

9 MACHINERY 



Balance 



10 



18,000.00 



EQUIPMENT AND TOOLS 



Balance 



ii 



5,400.00 



DELIVERY EQUIPMENT 



Balance 



12 



2,600.00 



RESERVE FOR DEPRECIATION OF BUILDINGS 



Bal. Jan. 

Dec. adjustment (3) 



RESERVE FOR DEPRECIATION OF MACHINERY 



2,000.00 
400.00 



Bal. Jan. 

Dec. adjustment (4) 



RESERVE FOR DEPRECIATION OF EQUIPMENT AND TOOLS 



7,200.00 
900.00 

8,100.00 



Bal. Jan. 
Adjustment (5) 



NOTES PAYABLE 



860.00 
485.00 



16 



Balance 



ACCOUNTS PAYABLE 



4,000.00 



Balance 



MORTGAGE PAYABLE 



16,000.00 



Balance 



12,000.00 



i8 



ACCOUNTING END OF PERIOD 

JOHN MORGAN CAPITAL 



205 



Jan. Balance 
Profit for year (3) 



SALES 



46,858.00 

7,957-QQ 

54,815.00 



Closed to P. & L. (i) 



20 



65,000.00 



Balance 



PURCHASES 



65,000.00 



Balance 



22 



23 



24 



25 



40,000.00 



Closed to P. & L. (2) 



TAXES 



INSURANCE 



ADVERTISING 



SALESMEN'S SALARIES 



GENERAL OFFICE SALARIES 



40,000.00 



Balance 
Accrual (12) 


120.00 

160.00 


Closed P. & L. (2) 280.00 


280.00 


280.00 







Balance 


240.00 


Adjustment (7) 
Closed P. & L. (2) 


80.00 
160.00 


240.00 


240.00 



Balance 


600.00 


Adjustment (8) 
Closed P. & L. (2) 


1 20.00- 
480.00 


600.00 


600.00 



Balance 
Accrued (13) 


8,400.00 
280.00 


Closed P. & L. (2) 


8,680.00 


8,680.00 


8,680.00 



Balance 
Accrual (14) 


6,200.00 
210.00 


Closed P. & L. (2) 


6,410.00 


6,410.00 


6,410.00 



206 

26 


FUNDAMENTALS OF ACCOUNTING 

INTEREST EXPENSE 




Balance 372.00 
Accrual (9) 360.00 
Accrual (10) 18.00 


Closed P. & L. (2) 


750.QQ 
750.00 


27 


750-00 


INTEREST INCOME 


Closed to P. & L. (i) 152.00 
152.00 


Balance 
Accrual (n) 


132.00 
20.00 


152.00 


28 


PROFIT AND Loss SUMMARY 


Adj. (i 
Closing 
Closing 

29 


a) Old Tnv. 12,000.00 
(2) Expenses 59,695.00 
(3) Profit to Capital 7,957.00 


Adj. (i) New Inv. 
Closing (i) Income 


14,500.00 
65,152.00 


79,652.00 


79,652.00 


PROVISION FOR DOUBTFUL ACCOUNTS 


Adj. (2) 
30 


650.00 


Closed P. & L. (2) 


650.00 


DEPRECIATION OF BUILDINGS 


Adj. (3) 


400.00 


Closed P. & L. (2) 


400.00 


31 DEPRECIATION OF MACHINERY 


Adj. 
32 


900.00 


Closed P. & L. (2) 


900.00 


DEPRECIATION EQUIPMENT AND TOOLS 


Adj. (5) 
33 


485.00 


Closed P. & L. (2) 
ELIVERY EQUIPMENT 


485.00 


" 
DEPRECIATION OF D 




Adj. (6) 


500.00 


Closed P. & L. (2) 


500.00 



34 



ACCOUNTING END OF PERIOD 

RESERVE FOR DEPRECIATION OF DELIVERY EQUIPMENT 



207 



35 



Adj. (6) 



UNEXPIRED INSURANCE 



500.00 



Adj. (7) 



80.00 



UNEXPIRED ADVERTISING 



Adj. (8) 



37 



120.00 



INTEREST ACCRUED ON MORTGAGE 



Adj. (9) 



INTEREST ACCRUED ON NOTES PAYABLE 



360.00 



39 



Adj. (10) 



INTEREST ACCRUED ON BONDS 



18.00 



Adj. (n) 



40 



20.00 



TAXES ACCRUED 



Adj. (12) 



SALESMENS SALARIES ACCRUED 



160.00 



Adj. (13) 



GENERAL OFFICE SALARIES ACCRUED 



Adj. (14) 



280.00 



2IO.OO 



208 



FUNDAMENTALS OF ACCOUNTING 



POST CLOSING TRIAL BALANCE 



The concluding step in the demonstration is the preparation 
of a post closing trial balance. 



POST CLOSING TRIAL BALANCE 



1. Cash 

2. Notes Receivable 

3. Accounts Receivable 

4. Reserve For Doubtful Accts 

5. Inventory (New) 

6. American Can Bonds 

7. Land 

8. Buildings 

9. Machinery 

10. Equipment & Tools 

11. Delivery Equipment 

12. Reserve for Depr. of Bldgs 

13. Reserve for Depr. Machinery 

14. Reserve Depr. Equip. & Tools .... 

15. Notes Payable 

16. Accounts Payable 

17. Mortgage Payable 

1 8. John Morgan, Capital 

34. Reserve Depr. Delivery Equip. . . . 

35. Unexpired Insurance 

36. Unexpired Advertising 

37. Interest Accrued on Mortgage .... 

38. Interest Accrued on Notes Payable 

39. Interest Accrued on Bonds 

40. Taxes Accrued 

41. Salesmen's Salaries Accrued 

42. General Office Salaries Accrued . . . 



6,42O.oo 

2,000.00 
24,180.00 

14,500.00 

2,000.00 

6,000.00 

20,000.00 

18,000.00 
5,400.00 
2,600.00 



80.00 

I2O.OO 



$ 1,132.00 



20.00 



2,400.00 

8,100.00 



4,000.00 

16,000.00 

12,000.00 

54,815.00 

500.00 



360.00 
18.00 

160.00 
280.00 

2IO.OO 

$101,320.00 $101,320.00 



QUESTIONS ON THE CHAPTER 

1. What is your understanding of the Cash Basis of account 
keeping? 

2. When books are kept on the cash basis, why should they be 
adjusted? 

3. (a) State four different types of adjustments. 

( b ) Illustrate by journal entry the adjustment required in each 
case. 

(c) Explain the twofold effect of each entry. 

4. A bookkeeper once said, " The writing of adjustment entries 



ACCOUNTING END OF PERIOD 209 

is an entirely unnecessary thing, because in the long run they do not 
vary the net Profit or Loss." He explained further that it made no 
difference if June did absorb May's expenses, or July received some 
of June's income, because May absorbed April's expense, and no 
doubt June would get part of May's income. Comment on this. 

5. Distinguish between an adjusting and a closing entry. 

6. Why must nominal accounts be closed? 

7. (a) What is an after adjustment trial balance? 
(b) What is an after closing trial balance? 

8. If statements have been prepared at the end of the year by use 
of a work sheet, will it be necessary for the bookkeepers to write ad- 
justing and closing entries just the same? Why or why not? 

9. Explain how we adjust for the New Inventory. 

10. Outline the entries required to close a set of books, 
n. What are the differences between a Profit and Loss Account 
and a Profit and Loss Statement? 

12. (a) Explain why wages may have to be accrued. 
(b) Give typical entries. 



PROBLEM MATERIAL 

PROBLEM i 

The following trial balance was taken from the books of the Brown 
and Green Store at November 30: 

Accounts Receivable $ 38,742.90 

Reserve for Doubtful Accounts $ 524.00 

Inventory Merchandise 5/31/39 ... 12,714.74 

Accounts Payable 42,970.00 

Notes Payable 30,000.00 

Notes Receivable 2,200.00 

Store Equipment 16,000.00 

Reserve for Dep. of Store Equipt. . . 3,200.00 

Delivery Equipment 22,480.00 

Reserve for Dep. of Delivery Equipt. 4,960.00 

Drivers' Salaries 5,000.00 

Salesmen's Salaries 15,720.00 

Clerks' Salaries 3,614.36 

Executive Salaries 8,000.00 

Advertising 4,200.00 

Freight Inward 810.60 

Sundry Delivery Expenses 121.40 

Gas, Oil & Tire Expense 1,319-25 

Cash in Banks 11,416.75 

Change Funds 1,200.00 

General Office Expense 624.00 

Auto Insurance 1,840.00 

General Insurance 622.00 

Interest Expense 4 2 - 



2io FUNDAMENTALS OF ACCOUNTING 

Interest Income $ 176.00 

John Brown Personal $ 5,000.00 

John Brown Capital 24,200.50 

Thomas Green Personal 3,500.00 

Thomas Green Capital 15,160.20 

Purchases 67,943.20 

Sales 102,486.50 

Sales Returns & Allowances 1,380.50 

Purchase Returns & Allowances .... __ 814.50 

$224,491.70 $224,491.70 

Adjustment Data: 

(1) The Inventory of Merchandise on hand is valued at 
$16,840.90. 

(2) Increase the Reserve for Doubtful Accounts by i% of Ac- 
counts Receivable. 

(3) Accrue Salaries as follows: Drivers $200.00; Salesmen 
$612.00; Clerks $96.00. 

(4) The unexpired Advertising is valued at $1200.00. 

(5) There is unexpired Auto Insurance of $216.00, and General 
Insurance of $72.00. 

(6) Interest on Notes Payable of $900.00 is to be accrued; this 
is payable December ist. 

(7) Interest on Notes Receivable is to be accrued in the amount 
of $24.20. 

(8) Increase the Reserve for Depreciation of Store Equipment 
$800.00. 

(9) Current Depreciation on Autos is calculated as $448.00. 

Required: 

(1) Write in a two-column general journal the entries necessary 
to adjust and close the books. In this respect the partners 
share profits and losses equally, and you are to close any gain 
or loss to the partners' personal accounts, which in turn are 
to be closed to the partners' capital accounts. 

(2) Prepare an accountant's work sheet. 

(3) Prepare a profit and loss statement and a balance sheet. 

(4) Prepare accounts for the profit and loss summary, the part- 
ners' capital and personal accounts, post entries affecting these 
accounts and balance them. 

PROBLEM 2 

The following trial balance was taken from the books of O. Mc- 
Clave at August i, 19 : 

Cash $ 12,210.19 

Accounts Receivable 21,900.70 

Notes Receivable 2,476.50 

Reserve for Doubtful Accounts $ 486.72 

Inventory Feb. i 16,470.84 



ACCOUNTING END OF PERIOD 211 

Land & Buildings $ 40,000.00 

Res. for Dep. of Buildings $ 700.00 

Taxes 620.00 

Insurance 185.80 

Advertising 2,200.00 

Machinery & Equipment 14,000.00 

Res. for Dep. of Mach'y & Equip. . . 1,400.00 

Office Equipment 1,680.00 

Res. for Dep. of Office Equip 168.00 

Accounts Payable 18,472.63 

Notes Payable (short term) 3,000.00 

Mortgage Payable 20,000.00 

Interest Expense 640.70 

Salesmen's Salaries & Commission . . 4,384.00 

McClave Capital 61,674.10 

Sales 82,750.48 

Purchases 65,107.30 

Inward Freight 418.70 

Delivery Expense 1,685.20 

Postage, 22.00 

Finance Notes Payable (1-3 yrs.) . . 1,850.00 

Trade Acceptances Receivable 3,200.00 

General Office Salaries 3,300.00 

Totals $190,501.93 $190,501.93 

Adjustment Data: 

1. The Merchandise Inventory on hand is valued at $15,871.40. 

2. The Accounts Receivable and Notes Receivable have been eval- 
uated and it is decided that $174.07 should be added to the Re- 
serve for Doubtful Accounts. 

3. The annual depreciation rates as follows: Buildings 2% which 
are separately valued at $35,000.00; Machinery and Equipment 
6%] Office Equipment 5%. Provide proper additions to the 
several reserve accounts. 

4. There is due Salesmen as commissions earned but not paid 
$165.00. 

5. Salaries of General Office workers to be accrued amount to 
$184.00. 

6. Interest on the Mortgage in amount of $200.00, and of $12.40 
on Notes Payable is to be accrued. 

7. There is $36.00 to be accrued on one Note Receivable, all other 
notes have paid their interest to date. 

8. There is Advertising Unexpired valued at $600.00. 

Required: 

1 i ) Prepare an accountant's work sheet. 

( 2 ) Prepare a balance sheet and a profit and loss statement in good 
form. 



CHAPTER XIII 

ACCOUNTING AT THE END OF THE FISCAL 
PERIOD (Concluded} 

REVERSAL ENTRIES 

In the last chapter a complete illustration of adjusting and 
closing the books was presented. The example was concluded 
with a post-closing trial balance. It will be necessary, before 
the transactions of the next period are entered in the accounts, 
to record certain so-called reversal or re-adjusting entries. In 
our example, for instance, there appear two accrued salary ac- 
counts : Salesmen's Salaries Accrued and General Office Salaries 
Accrued. Accounts such as these represent a definite liability 
of the company to pay the salary. This will be done, in most in- 
stances, the next pay day. Such a payment will, of course, 
liquidate the liability of the company. Since these salaries, 
when paid, will be charged against the expense accounts Sales- 
men's Salaries and General Office Salaries, it will be necessary to 
reverse the former adjustment entries. The accrued portion of 
the current pay-roll is transferred from the Salaries Accrued 
accounts to the Salary accounts. In our case this is accom- 
plished by the two entries which follow: 

GENERAL JOURNAL 
i 

Salesmen's Salaries Accrued 41 $280.00 

Salesmen's Salaries 24 $280.00 

To close the accrued salaries account 
and transfer the balance to the expense 
account. 

-2- 

General Office Salaries Accrued 42 $210.00 

General Office Salaries 25 $210.00 

To close the accrued salaries account 
and transfer the balance to the expense 
account. 

After these entries have been posted and the salaries due on 
the next pay day January 4, 19 paid, which we shall assume 

212 



ACCOUNTING END OF PERIOD 



213 



is $500.00 to salesmen and $480.00 to the general office work- 
ers, then the accounts would look as follows: 



SALESMEN'S SALARIES 



194- 

Dec. 31 Total Paid 

(details omitted 
for convenience) $8,420.00 
Accrued Adj. 

entry 13. 280.00 

$8,700.00 



Jan. 4 Pay-roll for week 500.00 



Dec. 31 Closing entry 
To P. & L. Summary 



Jan. 2 Reversal (i) 



1,700.00 



$8,700.00 
280.00 



SALARIES OF SALESMEN ACCRUED 



Jan. 2 Reversal (i) 



$280.00 



Dec. 31 Adj. 13 



$280.00 



GENERAL OFFICE SALARIES 



IQ4- 


Total salaries 




Closed to P. & L. 




Dec. 


31 paid (Details 




Summary 


$6,410.00 




omitted) 


$6,200.00 








Accrual Adj. 










Entry 14 


210.00 










$6,410.00 




$6,410.00 


Jan. 


4 Pay-roll 


480.00 


Jan. 2 Reversal 


210.00 



42 



GENERAL OFFICE SALARY ACCRUED 



Jan. 2 Reversal 



$210.00 



Dec. Adjustment 
Entry 14 



$210.00 



A study of the accounts above will reveal that the reversal 
entries make it possible for the current period to be relieved of 
the salaries expense which was absorbed in the last period, 
where it rightfully belonged; and at the same time charge the 
new period with the current salary expense. At the end of the 
current year any salaries earned by the salesmen or general 
office force, but not paid, will have to be added to the respective 
salary expense accounts and credited to the accrued salary ac- 
counts once more by means of adjustment entries. 

In a similar manner reversal entries will also have to be writ- 
ten to close the Unexpired Advertising and the Unexpired In- 



214 FUNDAMENTALS OF ACCOUNTING 

surance accounts, respectively, to the Advertising and Insur- 
ance accounts. This is accomplished by the following journal 
entries : 

GENERAL JOURNAL 

-3- 

Advertising 23 $120.00 

Unexpired advertising 36 $120.00 

To reverse the accrual. 

-4- 

Insurance 22 $ 80.00 

Unexpired insurance 35 $ 80.00 

To reverse the accrual. 

After these entries have been posted the accounts affected in 
the ledger will look as follows : 

23 ADVERTISING 



Total Paid 
Jan. Reversal (3) 
36 


$600.00 


Adjustment (8) Dec. 
Closed to P. & L. Dec. 

ADVERTISING 


$120.00 
480.00 


$600.00 


$600.00 


1 20.00 
UNEXPIRED 




Dec. Adjust. 8 

22 


$120.00 


Jan. 
Reversal (3) 


$120.00 


INSURANCE 


Total paid 
Jan. 4 Reversal 4 

35 


$240.00 


Dec. Adjustment 7 
Closed to P. & L. 

INSURANCE 


$ 80.00 
160.00 


$240.00 


$240.00 


80.00 
UNEXPIRED 




Dec. Adjustment 7 


$80.00 


Reversal 4 


$80.00 







A study of the accounts above will reveal that the respective 
expense accounts have had charged to them the amounts which 
were taken out by proper adjustment entries at the close of the 



ACCOUNTING END OF PERIOD 



215 



last accounting period. The amounts now in the Advertising 
and Insurance accounts will be absorbed in the new year, to- 
gether with any other Advertising or Insurance which may be 
purchased in that year. Of course, it will be necessary to write 
adjustments at the end of the next year for any portion of these 
expenses which might be unexpired at that time. 

Three accrued liability accounts; Interest Accrued on Mort- 
gages, Interest Accrued on Notes Payable, and Taxes Accrued 
will also have to be reversed, and the respective expense ac- 
counts credited so that the expenses of the new period will not be 
charged with these expenses which, by proper adjustment en- 
tries, were absorbed in the last year. 

The following reversal entries will accomplish this purpose: 

GENERAL JOURNAL 

-5- 

Interest Accrued on Mortgage 37 $360.00 

Interest Expense 26 $360.00 

To reverse. 



Interest Accrued on Notes Payable ... 38 $ 18.00 

Interest Expense 26 $ 18.00 

To reverse 

-7- 

Taxes Accrued 40 $160.00 

Taxes 21 $160.00 

To reverse 

After reversal entries 5, 6, and 7 above have been posted, the 
ledger accounts affected will look as follows : 

26 INTEREST EXPENSE 



Total paid 
Accrual Adjustment 9 
Accrual Adjustment 10 


$372.00 
360,00 
18.00 


Closed on P. & L. 

Jan. 2. Reversal 5 
Jan. 2. Reversal 6 


$750.00 


$750.00 


$750.00 




360.00 
18.00 



37 



INTEREST ACCRUED ON MORTGAGE 



Reversed 5 



$360.00 



Adjustment 9 



$360.00 



2i6 FUNDAMENTALS OF ACCOUNTING 

38 INTEREST ACCRUED ON NOTES PAYABLE 



Reversed 6 



$ 18.00 



Adjustment 10 



$ 18.00 



A study of the Interest Expense account above will indicate 
that, as the several interest items are paid during the year, only 
the amounts which should rightfully be absorbed in the new year 
will be included, because the present credit balance of $378.00 
was absorbed in the last fiscal year, where it rightfully belonged. 
In a somewhat similar manner the accrued asset account, In- 
terest Accrued on Bonds, will have to be reversed, and the 
Interest Income account debited for the $20.00 interest accrued 
in December. 

The following reversal entry will conclude the reversal en- 
tries required for the John Morgan Company: 

GENERAL JOURNAL 

-8- 

Interest Income 27 $ 20.00 

Interest Accrued on Bonds 39 $ 20.00 

To reverse. 

After this reversal entry has been posted, the Interest In- 
come and Interest Accrued on Bonds accounts will look as 
follows : 

27 INTEREST INCOME 



Dec. Closed to P. & L. 
Jan. Reversal 8 


$152.00 


Total collected 
Dec. Accrued adj. ii 


$132.00 
20.00 


$152.00 


$152.00 


$ 20.00 





39 



INTEREST ACCRUED ON BONDS 



Dec. Adjustment 11 



$ 20.00 



Jan. Reversal 8 



$ 20.00 



VARIATION IN ACCOUNTING TECHNIQUE WHEN FINANCIAL 
STATEMENTS ARE PREPARED FREQUENTLY 

The entire example illustrating adjustments for inventory, 
bad debts, depreciation, accruals, and deferred items, together 



ACCOUNTING END OF PERIOD 217 

with closing entries and subsequently reversal entries, presup- 
posed that financial statements were prepared only once each 
year. In such a case the adjusting, closing, and reversal entries 
being required only once a year would not be too bothersome. 
If, however, financial statements are required more frequently, 
such as once a month as in many companies, then this procedure 
would be most inconvenient. 

When financial statements are required monthly, they are 
frequently prepared directly from work sheets, and the books 
need not be closed more than once a year. The adjustment en- 
tries are written monthly directly to the work sheet from 
which the profit and loss statement and the balance sheet are 
prepared. If statements are prepared monthly, certain mixed 
accounts, those part nominal and part real, may be treated 
differently from those in our last illustration taken from the 
books of the John Morgan Company. 



PREPAID INSURANCE 

A good example of such a mixed account is one which results 
if a fire insurance policy is purchased which will benefit more 
than one period and where the premium is paid in advance. 

As a case study let us assume that B. Kent operates a small 
factory and has monthly financial statements prepared for his 
aid in managing the enterprise. Let us further suppose that 
on July i, 1940 he paid $240.00 premium for a two-year fire 
insurance policy. 

At that date the following journal entry should be written: 

GENERAL JOURNAL 

Prepaid Fire Insurance $240.00 

Cash $240.00 

To record payment of premium on Fire 
Policy No , expiring July i, 1942 

By this entry the expenditure is immediately charged to a 
deferred asset account; therefore, at the end of July it will be 
necessary only to calculate the month's pro-rata share, and by 
an appropriate adjustment entry charge July with one month's 
insurance cost. The premium $240.00 divided by 24 months,. 



2i8 FUNDAMENTALS OF ACCOUNTING 

on a pro-rata basis, would give a $10.00 monthly insurance 
charge. The following journal entry will adjust at July 31,1 940. 

Insurance $ 10.00 

Prepaid Insurance $ 10.00 

To charge July with one month's in- 
surance cost. 

By this adjustment entry the value of prepaid insurance is 
reduced to $230.00, its value at July 31, and at the same time 
the insurance expense for July is just $10.00. This adjustment 
entry is written directly to the work sheet and the Prepaid In- 
surance account as adjusted $230.00 will be carried over to the 
debit column of the balance sheet group, while the Insurance 
Expense $10.00 is transferred to the nominal debit column. No 
reversal entry is required when this procedure is followed. An- 
other similar adjustment is made at the end of August and each 
month thereafter, at which time the Insurance account is debited 
$10.00 and the Prepaid Insurance account reduced accordingly, 
which, after twenty- four months will have been entirely ab- 
sorbed in operating costs. 

This method is best for deferred expenses, when it is ex- 
pected that the expenditure will benefit more than one ac- 
counting period. Advertising is often contracted for and paid 
several months in advance, and if that is done the expenditure 
should be charged to Prepaid Advertising rather than to Adver- 
tising. At the end of each month an adjustment entry should 
be written; a debit to Advertising Expense, and a credit to the 
Prepaid Advertising account. This will result in the Prepaid 
Advertising being gradually absorbed into expense over the 
period served by the advertising. 

DEFERRED INCOME 

In a like manner, when financial statements are prepared 
monthly, and income is received in advance for more than one 
accounting period, it is more advantageous to credit this in- 
come directly to a Deferred Income account. For example, let 
us suppose that The Reel Life Magazine is published by the 
Mutual Film Company and that all subscriptions are received 
in advance. As cash is received for subscriptions it should be 
credited to a Deferred Income account such as Subscriptions 



ACCOUNTING END OF PERIOD 219 

Received in Advance. If this procedure is followed, as it usually 
is in magazine and newspaper offices, then at the end of the 
month the amount of subscriptions income which belongs to the 
current period is calculated. This amount is placed in an ap- 
propriate earning account such as Subscriptions Income, by 
an adjustment entry which debits the deferred income account 
Subscriptions Received in Advance, and credits Subscriptions 
Income. As an illustration, let us suppose that at July 31,1 94 
there appears a credit balance of $12,840.00 in the Subscrip- 
tions Received in Advance account. It is calculated that 
$1794.00 has been earned in July and the balance $11,046.00 
belongs to future months. The following entry then should be 
written to the work sheet: 

Subscriptions Received in Advance . $1794.00 

Subscriptions Income $1794.00 

To adjust the deferred income ac- 
count, and credit the current period 
with its share of subscription income. 

Another Deferred Income account handled in a similar man- 
ner is one created when rentals are received in advance. Let 
us suppose that the Mutual Film Company rents out part of its 
buildings and receives rentals quarterly in advance; that it 
received $360.00 rental July ist for the months of July, August, 
and September. Just as soon as the cash is received it is credited 
to the Dej erred Income account, Rentals Received in Advance 
instead of to an income account. Then, at the close of the 
monthly period July 31, by means of an adjusting entry, the 
current period is credited with $120.00, its proportioned share. 
The balance $240.00 will remain in the deferred income account. 
The following adjustment entry will accomplish this: 

Rentals Received in Advance $120.00 

Rental Income $120.00 

To transfer to July its proportionate 
share of Rental Income. 

This entry is written directly to the work sheet and will re- 
sult in a credit of $120.00 to July as Rental Income, and at the 
same time defer the balance $240.00 to be absorbed in August 
and September. 



220 FUNDAMENTALS OF ACCOUNTING 



DEMONSTRATION EXERCISE 

At this point it will be helpful to present a complete case, 
utilizing some of the principles just presented. The illustration 
is based on a trial balance taken from the records of the Thomas 
Clark Supply Company at June 30, 19 . The company has 
prepared financial statements monthly, from work sheets, but 
the books have not been closed since last September. Each 
month appropriate adjustments were written and posted to the 
ledger. The trial balance has been written directly to the work 
sheet, and the following adjustments are determined to be neces- 
,sary, for the month of June : 

1 i ) The value of Merchandise on hand June 30 is $58,000.00. 

(2) It is determined that an additional $120.00 should be added to 
the Reserve for Doubtful Accounts. 

(3) The monthly charge for Depreciation of Buildings is $33.34. 

(4) The monthly charge for Depreciation of Machinery and Equip- 
ment is $100.00. 

(5) The present advertising contract in amount of $1600.00 was 
paid for June i and covers advertising for the months of June, 
July, August, and September. 

(6) An examination of the Prepaid Insurance account indicates that 
$360.00 was paid for a one-year policy. This is being charged 
to expense at the rate of $30.00 per month. 

(7) June tax expense is calculated to be $100.00. 

(8) The account Rentals Received in Advance represents rentals 
received June i, for June, July, August, and September. 

(9) Accrued Salaries for June as follows: Salesmen $140.00, Gen- 
eral Office $180.00. 

(io) There is $20.00 interest earned in June to be accrued. 
( ii ) There is $15.00 interest on notes payable to be accrued. 

The adjustments required at June 30, in accordance with the 
data above, have been written directly to the work sheet exactly 
as would be done in practice. The adjustment numbers used 
above have been placed alongside each entry on the work sheet, 
to help trace the entries. It will be helpful if the student will 
read the following brief explanation of why each adjustment 
is written as it is, and by use of the adjustment numbers trace 
each adjustment to the work sheet. 

Entry lA. This is a transferring entry written to bring down 
the cost of the Old Inventory to the Profit and Loss Summary. 



ACCOUNTING END OF PERIOD 221 























































































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222 FUNDAMENTALS OF ACCOUNTING 

Entry i. This entry places the New Inventory on the work 
sheet as an asset, and at the same time the credit to the Profit 
and Loss Summary reduces the cost of goods sold. 

Entries 2, 3, and 4. These entries were written to increase 
the reserves as directed. In each case the student should note on 
the work sheet that provision for Bad Debts, and the Depre- 
ciation accounts have been added to monthly but have not been 
closed. 

Entry 5. This entry was written to reduce the current value 
of prepaid advertising. Since the contract in amount of 
$1600.00 covered the months of June, July, and August, and 
was paid in June, then three-quarters of this prepaid advertis- 
ing should be deferred. A study of the Advertising account on 
the work sheet would indicate that evidently $2000.00 worth of 
advertising had expired during the past five months, and a new 
contract purchased for June and the next three months. 

Entry 6. This entry adjusts the Prepaid Insurance account 
in a manner similar to that used for Prepaid Advertising above. 

Entry 7. This entry is written so that June will be charged 
with its share of taxes, and so that Prepaid Taxes account may 
be reduced accordingly. 

Entry 8. The eighth entry is written so that June will be 
credited with its share of rental income, and so that Rentals Re- 
ceived in Advance may be reduced accordingly. 

Entry 9. This entry is written to charge the salesmen's sala- 
ries and general office salaries with the respective accrued 
salaries, and to show the liability for Accrued Wages Payable. 

Entry 10. The purpose of this entry is to credit June Inter- 
est Income with $26.00 earned in June, but which will be col- 
lected subsequently. 

Entry n. The last adjustment entry charges June interest 
expense with $15.00, the Interest Accrued on Notes Payable. 

COMPLETION OF THE WORK SHEET 

After the adjustment entries have been placed on the work 
sheet, the next step is to consolidate the first four columns into 
the Trial Balance After Adjustment. Beginning students will 



ACCOUNTING END OF PERIOD 223 

find that the preparation of this adjusted trial balance is help- 
ful. It will prove, if the mechanical work has been done cor- 
rectly. If the totals do not agree, the student should find his 
error before he proceeds. Experienced accountants often omit 
the Trial Balance After Adjustment, and as the accounts are 
adjusted place them directly in one of the four columns on the 
right where they belong. The student will do well to study 
carefully the placing of each account. 



FINANCIAL STATEMENTS FROM COMPLETED WORK SHEET 

The Profit and Loss Statement and the Balance Sheet may 
now be prepared from the completed work sheet. The forms 
are similar to those used before and are presented on the fol- 
lowing pages to complete the demonstration. 

For questions on this chapter see page 228. 



224 



FUNDAMENTALS OF ACCOUNTING 



THE THOMAS CLARK SUPPLY Co. 



Profit and Loss Statement 
For the Six Months Period Ended June 30, 



19 



Gross Income from Sales $156,000.00 

Less Return Sales 300.00 

Net Income from Sales 155,700.00 

Deduct the Cost of Goods Sold: 

Inventory May 31 $ 60,000.00 

Add Purchases $105,800.00 

Less Returned Pur- 
chases 500.00 

105,300.00 

Total Merchandise, Available for 

Sale 165,300.00 

Less Inventory June 30 58,000.00 

Cost Of Goods Sold 107,300.00 

Gross Profit on Sales 48,400.00 

Deduct Expenses of Operation: 

A. Selling Expenses: 

Salesmen's Salaries . 23,140.00 

Advertising 2,400.00 

25,540.00 

B. General and Administrative Expense: 
Freight & Cartage . 600.00 
General Off. Sal. . . 18,180.00 
Provision for Doubt- 
ful Accounts .... 720.00 

Depr. of Bldgs 200.00 

Depr. of Machy. & 

Equip 600.00 

Insurance 180.00 

Taxes 600.00 

21,080.00 

Total Expenses of Operation 46,620.00 

Net Profit from Operations . . 1,780.00 

Add Non-Operating Income: 

Purchase Discounts 1,200.00 

Interest Income 520.00 

Rental Income 1,200.00 

2,920.00 
Less: 

Sales Discounts 335-OO 

Interest Expense .... 9QQ.QQ 1,235-00 1,685.00 
Net Profit for the Period $ 3465.00 



ACCOUNTING END OF PERIOD 225 

Balance Sheet 
As of June 30, 194 

ASSETS 
Current Assets 

Cash $ 3,000.00 

Accounts Receivable .... $12,000.00 
Less Res. Doubt. Accts. 720.00 

11,280.00 

Inventory 58,000.00 

Temporary Investments . . 2,000.00 

Accrued Interest 20.00 

2,020.00 

Total Current Assets $ 74,300.00 

Fixed Assets 

Land 8,000.00 

Buildings 20,000.00 

Less Deprec. Res 900.00 

19,100.00 
Machinery & Equipment . 12,000.00 

Less Deprec. Res 2,900.00 

9,100.00 

Total Fixed Assets 36,200.00 

Deferred Charges 

Prepaid Advertising 1,200.00 

Prepaid Insurance 180.00 

Prepaid Taxes 1,100.00 

Total Deferred Charges 2,480.00 

Total Assets $112,980.00 

LIABILITIES AND NET WORTH 
Current Liabilities 

Accounts Payable $34,000.00 

Notes Payable $10,000.00 

Accrued Interest 15.00 10,015.00 

Rentals Received in Advance 600.00 

Salaries Accrued 320.00 

Total Current Liabilities $ 44,93 5 -oo 

Net Worth 

Thomas Clark 67,580.00 

Less Drawings 3,000.00 

64,580.00 

Add Net Profit for Period 3 465-00 

68,045.00 
Total Liabilities and Net Worth $112,980.00 



226 



FUNDAMENTALS OF ACCOUNTING 



PROBLEM MATERIAL 



PROBLEM i 

The G. G. Hill Company, a sole proprietorship, has had quarterly 
financial statements prepared from a series of Work Sheets. The 
general ledger reveals the following balances at December 3ist: 

Land $ 5,000.00 

Buildings 25,000.00 

Res. for Dep. of Buildings $ 2,375.00 

Delivery Equipment 8,000.00 

Res. for Dep. of Delivery Equip. . . . 1,560.00 

Purchases 110,568.72 

Sales 146,928.60 

Salesmen's Salaries 13,000.00 

General Office Salaries 7,480.00 

Cash 17,240.38 

Accounts Receivable 31,720.10 

Notes Receivable 16,840.25 

Reserve for Doubtful Accounts 634.20 

Notes Payable 1 2,500.00 

Purchase Discounts 1,245.00 

Sales Discounts 1,184.00 

Interest Expense 240.00 

Interest Income 184.00 

Prepaid Insurance 1,640.00 

Prepaid Advertising 3,200.00 

Rental Income 1,100.00 

Rentals Collected In Advance 1,800.00 

Advertising Expense 2,600.00 

Insurance Expense 820.00 

Taxes 796.00 

Accrued Interest Receivable 114.00 

Accrued Interest Payable 80.00 

Mortgage Payable 18,000.00 

Accounts Payable 26,840.40 

G. Hill Capital 59,001.50 

Profit & Loss Summary 

Provision for Doubtful Accounts . . . 1,219.60 

Depreciation of Buildings 375-oo 

Depreciation of Delivery Equipment 600.00 

Inventory October i 24,610.65 

$272,248.70 $272,248.70 

Adjustment Data: 

1. The December 31 Inventory of Merchandise is valued at 
$28,946.74. 

2. Depreciation of Buildings for the present quarter is calculated 
to be $125.00. 

3. The Reserve for Doubtful Accounts is to be increased $284.00. 



ACCOUNTING END OF PERIOD 227 

4. Depreciation of Delivery Equipment for the current quarter is 
calculated to be $500.00. 

5. The present unexpired value of the Advertising Contract is 
$2400.00. 

6. The Prepaid Insurance at December 31 is calculated at 
$1440.00. 

7. Taxes are prepaid in amount of $124.00. 

8. Accrued Salaries are as follows: Salesmen $165; General Office 
$180. 

9. The Rentals Collected in Advance amount to $1400.00. 

10. Interest to be accrued for the current quarter on Notes Receiv- 
able $66.00, on Notes Payable $142.00, and on Mortgage Pay- 
able $400.00. 

Required: 

(1) Given the foregoing trial balance and adjustment data, pre- 
pare an accountant's work sheet. 

( 2 ) From the work sheet prepare a profit and loss statement and a 
balance sheet. 

PROBLEM 2 

Mr. John Stark operates the John Stark Trading Co., and in addi- 
tion publishes a trade journal. Financial statements are prepared 
monthly and the books closed semi-annually. The following trial bal- 
ance was taken from the records as of June 30, 19 . 

Cash $ 4,326.70 

Notes Receivable 2,000.00 

Accounts Receivable 17,840.60 

Res. for Doubtful Accounts $ 464.00 

Inventory Jan. i 20,480.00 

Purchases 142,816.75 

Sales 180,680.00 

Sales Returns 1,250.00 

Land 6,000.00 

Buildings & Equipment 40,000.00 

Delivery Equipment 8,400.00 

Depreciation of Del. Equip 700.00 

Res. for Dep. of Buildings 1,836.00 

Res. for Dep. of Del. Equip 3,360.00 

Depreciation of Buildings 300.00 

Prepaid Advertising 2,000.00 

Advertising Expense 1,000.00 

Prepaid Insurance 780.00 

Insurance Expense 300.00 

Salesmen's Salaries 14,280.20 

General Office Salaries 12,460.00 

Taxes 100.00 

Prepaid Taxes 140.00 

Mortgage Payable 25,000.00 

Notes Payable (Long Term) 12,500.00 



228 FUNDAMENTALS OF ACCOUNTING 

Accounts Payable $ 22,560.25 

Interest Expense $ 640.00 

Interest Income 50.00 

Subscriptions Income 1,000.00 

Subscriptions Collected in Advance . 3,684.00 

Notes Payable (Bank) 3,000.00 

John Stark Capital 21,680.00 

$275,814.25 $275,814.25 

Adjustment Data: 

1. The Merchandise Inventory on hand June 30 is valued at 
$21,948.00. 

2. Monthly depreciation charges are $60.00 for buildings and 
$140.00 for delivery equipment. 

3. Salesmen's Salaries in amount of $246.00 and General Office 
Salaries of $194.00 are to be accrued. 

4. The Prepaid Insurance is valued at $600.00. 

5. The Prepaid Advertising is valued at $1800.00. 

6. Prepaid Taxes are now valued at $120.00. 

7. Interest is to be accrued as follows: On Mortgage $125.00; on 
Notes Payable $62.50; on Notes Receivable $20.00. 

8. The current month is entitled to $320.00 Subscriptions Income. 

9. The Reserve for Doubtful Accounts was considered ample. 

Required: 

1 i ) Given the foregoing trial balance and adjustment data, pre- 
pare an accountant's work sheet. 

(2) From the work sheet prepare a profit and loss statement and a 
balance sheet. 



QUESTIONS ON THE CHAPTER 

1. (a) What do you understand by a reversal entry? 
(b) Explain how " accrued salaries " are reversed. 

2. (a) Explain how unexpired insurance is placed on the books 
when the records are kept on the cash basis. 

(b) How is this reversed? Why? 

3. Explain how prepaid advertising can be recorded on the books 
without the use of reversal entries. Give complete case; including 
the original purchase of the advertising; and the periodic charge to 
expense. 

4. Explain how rentals received in advance may be recorded in the 
records when statements are prepared monthly. Give a complete ex- 
planation and illustration. 

5. Give a complete illustration of subscriptions received in advance 
and of how this income is gradually absorbed over the subscription 
period. 



CHAPTER XIV 

PARTNERSHIP ACCOUNTING 

INTRODUCTION, FORMATION, AND DIVISION 

OF PROFITS 

INTRODUCTION 

The work of this text thus far has been confined to account- 
ing for the single proprietor. None of the problems brought 
into being by the corporate or partnership forms of business or- 
ganization have been considered. The next few chapters will 
discuss the accounting required by both of these forms of 
organization. 

It might be well at this time, therefore, to contrast the three 
principal forms of business organization : the single proprietor- 
ship, the partnership, and the corporation. 

THE SINGLE PROPRIETORSHIP 

The single proprietorship form of business organization by its 
name indicates that the ownership of the business is vested in 
one person. No legal requirements are imposed upon one wish- 
ing to assume full liability for the debts of the business, and, 
should the assets of the business be insufficient to pay the credi- 
tors in full, the personal estate of the sole proprietor may be 
used to satisfy the business liabilities. Thus we see in the sole 
proprietorship form of organization unlimited liability. This 
is probably the weakest point and the strongest argument 
against the single proprietorship form of organization. 

Two other arguments against this form of organization are: 
(i) the fact that the amount of capital a single individual can 
command is limited; and (2) that the death of the proprietor 
automatically terminates the business. This form of organiza- 
tion, however, best meets the need of the small business man, 
because it is so easy to start, and also to leave, if satisfactory 
results are not forthcoming. The management is in complete 
control of the owner; he can mold the business as he likes. He 
is the chief in command and can hire and fire and dictate 
any other policies he likes. Therefore, despite the weaknesses 

229 



230 FUNDAMENTALS OF ACCOUNTING 

mentioned, we find thousands upon thousands of men and women 
entering business as sole proprietors. This form of organiza- 
tion today is the most common, and as far as numbers of or- 
ganizations are concerned is by far the largest. 

THE PARTNERSHIP 

To correct some of the weaknesses of the single proprietorship 
form of organization the partnership form is very often resorted 
to. The ownership will be divided between two or more; and, 
while this takes any sole command and absolute supremacy 
from the single proprietor, he is rewarded by the fact that the 
new firm can usually command more capital and the new part- 
ners can be counted on to aid in the management of the enter- 
prise. The disadvantages of the single proprietary form of or- 
ganization are not overcome. The unlimited liability is even 
extended. The debts of the partnership must be satisfied, even 
to the extent of the partners 7 personal estates, should the busi- 
ness assets not prove sufficient. Creditors may sue any or all 
partners for the firm's debts, and quite often when one partner 
has a stronger personal estate than the others, creditors will 
collect the entire sum due from the richest partner. The part- 
ners then must settle between themselves, and should the others 
have nothing, then the partner who paid the claims will have 
to stand the entire loss himself. 

Thus we see that partners are jointly and severally liable for 
the debts of the firm, and, should the business assets be insuf- 
ficient to meet the debts of the firm, the personal estates of the 
partners may be attached to meet any deficit. This is the weak- 
est point of the partnership form of organization; and, today, 
although many new partnerships are being organized, the num- 
ber is declining; and many single proprietors wishing to 
expand, instead of looking for partners to aid, will go one step 
further into the corporate form of organization. 

Another outstanding weakness is the fact that the death of 
any partner automatically dissolves the partnership; and, while 
the remaining partner or partners may continue, a reorganiza- 
tion is necessary and many problems must be settled at this 
time. 

The ease of formation and the fact that no outside control 
will be exercised, as is the case with the corporation, and that 



PARTNERSHIP FORMATION PROFITS 2 3 1 

no special tax will be levied on the partnership as such, as the 
corporation is taxed, keep this form of organization popular 
where slight expansion is desired. 



THE CORPORATION 

The corporate form of organization was devised to meet the 
defects of both these types of organization. It remedies all of 
the weaknesses and adds several attractive features. The 
ownership may be divided almost indefinitely by means of trans- 
ferable shares, thus making possible large aggregate capital. 

The corporation, too, stands as a separate legal entity and 
may act as an individual person. It may enter into contracts in 
the corporation's name, and it may sue or be sued in the corpo- 
rate name. The chief feature, probably, is the fact that stock- 
holders r the real owners of the corporation, have no further lia- 
bility after their stock subscriptions are paid. This freedom 
from unlimited liability, which is the principal weakness of the 
other two forms of business organization, makes the corporation 
the ideal form of organization for large business. The corporate 
form possesses several other advantages as well as certain weak- 
nesses. Further consideration of the corporation shall be de- 
ferred, however, until we reach the chapter devoted to this most 
interesting phase of accounting. 

FORMATION OF A PARTNERSHIP 

It was said in the introduction that one of the weaknesses of 
the sole proprietorship form of business organization is the 
limitation of capital. This defect can be remedied by seeking a 
partner who is willing and able to aid in the business by combin- 
ing his services and capital in form of a partnership. 

It was also said in the introduction that no particular legal 
requirements were imposed upon those contemplating the for- 
mation of a partnership; and, although this is true, once organ- 
ized, there is a code of law designed particularly to help manage 
this form of business organization. 

It is necessary that one entering into a partnership be familiar 
with the law of partnerships. The scope of this text prevents a 
lengthy discussion of this interesting subject and only a few 
legal facts will be mentioned. 



232 FUNDAMENTALS OF ACCOUNTING 

The law which governs partnerships is State law and many 
States have codified this law. Prior to 1914, the law in several 
States differed, and the resulting conflict caused a great deal of 
confusion. In 1914 the National Conference of Commission- 
ers on Uniform State Laws caused a uniform law on partnership 
to be prepared. This same commission had, beside " The Uni- 
form Partnership Act," " The Uniform Limited Partnership 
Act " drawn up and presented to the various States of the union 
for their consideration. At the present time the majority of 
States have adopted the uniform act in its entirety or have 
adopted most of the act in codes of their own. 



PARTNERSHIP DEFINED 

The Uniform Partnership Act defines a partnership as 
" an association of two or more persons to carry on as co-owners 
a business for profit.' 7 

Another good definition is taken from Professor Mechem who 
says: " Partnership may be tentatively defined as a legal rela- 
tion based upon the express or implied agreement of two or more 
competent persons whereby they unite their property, labor or 
skill in carrying on some lawful business as principals for their 
joint profit." (Mechem, Partnership 2nd Ed. Sec. i.) 

From these two definitions we may say that the following are 
the elements of partnership: 

1. Partnership is the result of an agreement (expressed or implied) . 

2. Parties to the agreement must be competent to contract. 

3. The partnership is formed for a profit, and must have a legal pur- 
pose. 

4. The partners generally contribute money, property, labor, or skill. 

In organizing a partnership these elements should be kept 
in mind. 



PRELIMINARIES TO FORMATION OF PARTNERSHIP 

When a partnership is contemplated several preliminary mat- 
ters must be taken care of. 

First, the books of the single proprietor should be closed out 
and a balance sheet and profit and loss statement provided. 
These will be required in order that the new partner may know 



PARTNERSHIP FORMATION PROFITS 233 

the financial condition of the business he contemplates entering, 
and for several other uses as we shall presently see. 



ARTICLES OF CO-PARTNERSHIP 

After preliminary negotiations have been completed, a part- 
nership agreement should be drawn up. This agreement or 
contract is a very important part in the organization of a partner- 
ship. A partnership can come into existence without any writ- 
ten evidence of the fact, but such procedure is not wise, as many 
controversies and future differences of opinion can be avoided 
if the proper agreement is drawn at the start. 

It is also wise to employ some experienced party to aid in the 
drawing of this important paper, for, although anyone may 
draw it, the services of an experienced lawyer may be a good 
investment at this time. 

The partnership agreement should be drawn to meet the indi- 
vidual needs of the partners and each partnership will usually 
present many different problems. However, there are certain 
points which every good set of Articles should contain, and at 
this time a few of the most important are listed. 

IMPORTANT POINTS TO BE INCLUDED IN A 
PARTNERSHIP AGREEMENT 

1 i ) Names and addresses of the partners. 

( 2 ) The partnership firm name. 

(3 ) The date of commencement. 

(4) The location. 

(5) Capital contributions. 

(a) Total to be invested by each partner. 

(b) The make-up of the investment (i.e., cash or other as- 
sets). 

(c) Date each part of the investment is to be made, if entire 
investment is not to be received by the business at one 
time. 

(6) Interest, if any, to be allowed on partners' capital. 

(7) Salaries, if any, to be paid to partners. 

(8) Drawings: 

Limitations: penalties for overdrawing, such as interest 
charge, etc. 

(9) Duties of each partner: 

These should be clearly defined, however, with enough flexi- 
bility for each to know they are still co-owners. 



234 FUNDAMENTALS OF ACCOUNTING 

( 10) Accounting periods should be fixed and policy regarding regular 
auditing settled. 

(n) Basis of profit sharing: 

This is important because in absence of any agreement the 
law says profits and losses are to be shared equally by part- 
ners. 

( 12 ) Duration of the partnership and method of dissolution. 

Another most important phase of partnership, which, if prop- 
erly provided for in the partnership agreement, may avoid 
future trouble with regard to such matters as conditions un- 
der which dissolution may take place prior to the fixed term, 
and manner of settlement with deceased partner's estate in- 
cluding the valuation of good-will at the time of dissolution. 

After the Articles of Co-partnership have been agreed upon 
and signed, the accountant should prepare the books of record. 
One of the first things he should do at this time is to read and 
familiarize himself thoroughly with the partnership agreement. 
It is wise to have a copy of the Articles of Co-partnership 
pasted into the general journal. 

The next thing the accountant should do is to record the as- 
sets and liabilities contributed by the various partners. All 
property, real and personal, contributed by the partners, loses 
its former identity as belonging to the individual partners and 
becomes the property of the firm. 

The record required will take the form of journal entries and 
will be written into the General Journal directly following the 
Articles of Co-partnership. The forms these journal entries 
would take under several typical cases are illustrated here below. 



Case No. i 

Suppose A and B form a partnership, each partner contribut- 
ing his total investment in cash. Say A contributes $8000.00 
and B contributes $10,000.00 January 2. 

After the record of the partnership agreement has been writ- 
ten (which for brevity's sake will be omitted in all illustrations) , 
the following journal entry will be made: 

Cash V $ 8,000.00 

A Capital Account $ 8,000.00 

To record A 7 s investment in 
the A and B partnership. 



PARTNERSHIP FORMATION PROFITS 235 

Cash V $10,000.00 

B Capital Account $10,000.00 

To record B's investment in 
the A and B partnership. 

When these entries have been posted to the ledger the ac- 
counts would look as follows : 



CASH 



Jan. 2 $ 8,000.00 

10,000.00 



A CAPITAL 



Jan. 2 Investment $ 8,000.00 



B CAPITAL 



Jan. 2 Investment $10,000.00 



This is the simplest case and needs practically no explanation. 
The $18,000.00 received by the business should be deposited 
in the bank to the account of the A and B partnership. This 
amount should also be written into the cash receipts book in the 
appropriate money columns, so that the cash balance will be 
available in that book. In entering the cash balance in both 
journals care must be taken to prevent double posting. This 
may be avoided by the use of a check mark in the folio columns 
of both books, in the journal against Cash, and in the cash book 
against the two capital accounts. 

Case No. 2 

In this illustration let us suppose both A and B contribute 
several assets each, as follows: A, Cash $3000.00, a stock of 
merchandise valued at $2000.00, and an auto delivery truck 
which is valued at $1800.00; B, Cash $2800.00, the complete 
equipment for an office which is valued at $960.00, a stock of 



236 



FUNDAMENTALS OF ACCOUNTING 



merchandise which is valued at $2860.00, and a note receivable 
for $500.00. The following journal entries will open the books 
of the new partnership. 

GENERAL JOURNAL 

January 2 

Cash V $3000.00 

Inventory, Merchandise 2000.00 

Delivery Truck 1800.00 



A, Capital 

To record A's investment in the 
A and B partnership, as per agree- 
ment above. 

Cash 

Inventory, Merchandise 

Office Equipment 

Notes Receivable 

B, Capital 

To record B's investment in the 
A and B partnership, as per agree- 
ment above. 



$6800.00 



V 



2800.00 

2860.00 

960.00 

500.00 



7120.00 



After the entries above have been posted, a balance sheet pre- 
pared from the ledger of the A and B Partnership would look 
as follows: 

A AND B 

Balance Sheet as of January 2 



Assets 






Liabilities 




Cash 
Notes Receivable 
Inventory 
Auto Truck 
Office Equipment 


$ 5,800.00 
500.00 
4,860.00 
1,800.00 
960.00 


A, Capital 
B, Capital 


None 
Net Worth 


$ 6,800.00 
7,120.00 


$13,920.00 


$13,920.00 



This case is somewhat similar to the first, the only difference 
being that, whereas in the first case only cash was invested by 
the partners, in this case each contributed several assets. The 
form of journal entry will be the same, a debit to the assets re- 
ceived and a credit to each partner for the total amount of his 
net investment. Note again the check marks in the journal 
folio columns. These check marks, as mentioned before, are to 



PARTNERSHIP FORMATION PROFITS 237 

prevent double posting, when the cash invested by the part- 
ners is also entered in the cash receipts journal. 

Case No. 3 

Suppose that A, who conducts a wholesale drug business, and 
B, who is in the same line of business, agree to form a partner- 
ship in order to eliminate competition, and effect other econo- 
mies. A is to move all of his assets to the premises owned by B r 
which is large enough to take care of the contemplated expan- 
sion. Suppose as a basis of the partnership that the following 
balance sheets are mutually agreed upon. 

A. WHOLESALE DRUG STORE 
Balance Sheet as of December 3 1 



Assets 
Cash 
Notes Receivable 
Accounts Receivable 
Inventory 
Laboratory Equipment 
Delivery Equipment 


$16,200.00 
3,400.00 
7,280.00 
15,420.00 
3,000.00 
4,000.00 


Liabilities 
Notes Payable 
Accounts Payable 
Total Liabilities 
Net Worth 
A, Capital 


$ 4,500.00 
15,750.00 


$20,250.00 

29,050.00 
$49,300.00 


$49,300.00 



B. WHOLESALE DRUG STORE 
Balance Sheet as of December 3 1 



Assets 
Cash 
Notes Receivable 
Accounts Receivable 
Inventory 
Land & Buildings 
Laboratory Equipment 
Delivery Equipment 


$ 3,420.00 
4,000.00 
11,320.00 
15,640.00 
10,000.00 
5,000.00 
6,000.00 


Liabilities 
Notes Payable 
Accounts Payable 
Mortgage Payable 
Total Liabilities 

Net Worth 
B, Capital 


$ 5,000.00 
12,800.00 
6,000.00 


$23,800.00 
31,580.00 


$55,380.00 


$55,380.00 



The following journal entries will be necessary to open the 
new books of the partnership. 

Cash V $16,200.00 

Notes Receivable 3,400.00 

Accounts Receivable 7,280.00 

Inventory 15,420.00 



FUNDAMENTALS OF ACCOUNTING 



Laboratory Equipment $ 3,000.00 

Delivery Equipment 4,000.00 

Notes Payable $ 4,500.00 

Accounts Payable 15,750.00 

A, Capital Account 29,050.00 

To record the receipt of assets contrib- 
uted and liabilities assumed by the A 

and B partnership, the contribution of 
A as per agreement. 

Cash V $ 3,420.00 

Notes Receivable 4,000.00 

Accounts Receivable 11,320.00 

Inventory 15,640.00 

Land & Buildings 10,000.00 

Laboratory Equipment 5,000.00 

Delivery Equipment 6,000.00 

Notes Payable $ 5,000.00 

Accounts Payable 12,800.00 

Mortgage Payable 6,000.00 

B, Capital Account 31,580.00 

To record the receipt of assets contrib- 
uted and liabilities assumed by the A 

and B partnership, the contribution of 
B as per agreement. 

After the journal entries have been posted, a partnership bal- 
ance sheet may be prepared as follows : 



A AND B WHOLESALE DRUGGISTS 
Balance Sheet as of January 2 



Assets 
Cash 

Notes Receivable 
Accounts Receivable 
Inventory 

Laboratory Equipment 
Land and Buildings 
Delivery Equipment 



$ 19,620.00 

7,400.00 

18,600.00 

31,060.00 

8,000.00 

10,000.00 

10,000.00 

$104,680.00 



Liabilities and Capital 

Notes Payable $ 9,500.00 

Accounts Payable 28,550.00 

Mortgage Payable 6,000.00 

Total Liabilities 



A, Capital 

B, Capital 



Net Worth 



$ 44,050.00 



29,050.00 

31,580.00 

$104,680.00 



This case is the usual one when two going concerns unite in 
the partnership form of organization. Very frequently the cor- 
porate form of organization might be resorted to in a case like 
this. 

As in the two preceding instances, the cash contributed by 



PARTNERSHIP FORMATION PROFITS 239 

the partners should be entered also in the cash receipts book and 
checked in the journal as before. 

Note also on the partnership balance sheet that the property 
contributed by the two partners is merged. This is character- 
istic of property brought into the partnership. Property con- 
tributed by partners loses its former identity and belongs to the 
partnership, rather than to the partners individually. Each 
partner has control over the entire assets of the partnership, and 
can, in the usual course of the business, buy, sell, and act in every 
other capacity necessary to carry on the partnership business. 
The partnership agreement may limit the duties of the partners ; 
and, when such an agreement is present, that, of course, rules 
and governs the actions of each partner. 

Partners act for the partnership in all their dealings very 
much as agents, and the law of agency governs much of the 
partners' actions. " Every partner is an agent of the partner- 
ship for the purpose of its business etc." Uniform Partner- 
ship Act, Sec. 9(1). 

Not every act of a partner, however, is binding upon his co- 
partner any more than every act of an agent is binding on his 
principal. 

This last sentence may seem to limit the actions of partners, 
and in one sense it does. In general, any acts within the scope 
of the business may be performed by either, and either may 
bind the partnership. If, however, the acts of any partner are 
not within the scope of the business, then obviously the actions 
of one partner must be ratified by the other partners before the 
partnership can be bound. This is also covered in the Uniform 
Partnership Act, Section 9(2). " An act of a partner which is 
not apparently for the carrying on of the business of the part- 
nership in the usual way does not bind the partnership unless 
authorized by the other partners.' 7 

DIVISION OF PROFITS 

A very important feature in partnership acounting is that of 
sharing the profits or losses. The Uniform Partnership Act 
covers this point in Section 18, which states: " The rights and 
duties of the partners in relation to the partnership shall be de- 
termined, subject to any agreement between them, by the fol- 
lowing rules: (a) Each partner shall . . . share equally in the 



240 FUNDAMENTALS OF ACCOUNTING 

profits and surplus remaining after all liabilities, including those 
of the partners, are satisfied. . . ." Thus we see that in the 
absence of any specific agreement, profits or losses are to be 
shared equally. This subject, however, is usually covered by a 
clause in the partnership agreement and a definite method of 
distribution agreed upon by the partners. 

In practice there are many methods of sharing profits or 
losses. The following methods listed, and later described, are 
in common use today: 

VARIOUS BASES OF PROFIT DISTRIBUTION 

1. Shared equally. 

2 . Fixed or arbitrary ratio. 

3 . Ratio of partners' capital. 

4. According to the average capital invested over the ac- 

counting period. 

5. Interest on capital invested, before profits are distributed. 

6. Salaries as a division of profits. 

7. Combination of methods listed above. 

Each of these bases of profit and loss distribution is discussed 
below. 

I. PROFITS OR LOSSES SHARED EQUALLY 

When the partners' capital investments are equal, or where 
some other equalizing factors are present, there probably is no 
fairer way to distribute the profit or loss accruing to a partner- 
ship than by an equal division. When this condition prevails, 
a clause specifying the equal division of profits or losses should 
be included in the partnership agreement, even though the omis- 
sion of such an agreement would result in the same division. 
The advantage of including such a clause is that the question 
of distribution of profits or losses is settled by mutual agreement 
and the possibility of friction on this point is eliminated. 

The method of accounting for such a division is very simple. 
The following case is given for the sake of completeness. Sup- 
pose A, B, and C, whose capital investments in the "ABC" 
partnership are equal, are to share in a $6000.00 profit earned 
during the year ended December 31, 19 . 

The following entry will accomplish this: 



PARTNERSHIP FORMATION PROFITS 241 

GENERAL JOURNAL 

Profit and Loss $6000.00 

A, Capital $2000.00 

B, Capital 2000.00 

C, Capital 2000.00 

To distribute in three equal shares 

the net profit for the year ended De- 
cember 31, 19 . 

When this entry has been posted, the capital accounts of the 
partners will appear as follows: 

A CAPITAL 



Balance $10,000.00 

December J net profit for 
year 2,000.00 



B CAPITAL 



Balance $10,000.00 

December net profit for 
year 2,000.00 



C CAPITAL 



Balance $10,000.00 

December ^ net profit for 
year 2,000,00 



2. FIXED OR ARBITRARY RATIO 

Very often, even though the amounts of cash invested by the 
partners be equal, partners will agree to allow one partner to 
draw a larger share in the profits than the others. This con- 
dition of affairs will come about when the other elements of 
their investment, such as skill, which is hard to measure, are 
unequal Because this or other similar factors are hard to 
gauge, it becomes necessary for partners to agree upon a fixed 
ratio for dividing profits. 

Let us assume, therefore, that A and B members of the AB 
partnership have each invested $10,000.00 in a business, but 
because of A's particular knowledge and skill in this particular 



242 FUNDAMENTALS OF ACCOUNTING 

business, he is to be given 60% of all profits, while B is to re- 
ceive 40%. Let us suppose further that at December 31 there 
is a profit of $8000.00 to be divided on this ratio. The follow- 
ing journal entry will carry out the agreement: 

GENERAL JOURNAL 

Profit and Loss $8000.00 

" A " Capital $4800.00 

" B " Capital 3200.00 

To record the division of $8000.00, 

the net profit for the year, 60 per 

cent to A and 40 per cent to B. 

When this entry is posted the capital accounts will look as 
follows: 

A CAPITAL 



Balance $10,000.00 

December, 60 per cent of 
net profit 4,800.00 



B CAPITAL 



Balance $10,000.00 

December, 40 per cent of 

net profit 3,200.00 



3. RATIO OF PARTNERS' CAPITAL 

This method of dividing profits or losses is used quite fre- 
quently where cash investments are unequal, and where no other 
factors need be considered. Apportioning profits according to 
the amounts of capital invested, under these circumstances, is 
a very equitable method of distribution. 

Let us assume, as an example under this method, that A has 
invested $12 ,000.00, B $10,000.00, and C $i 5,000.00, and at the 
end of the year the firm has a $14,800.00 profit to be divided. 

Under this method the combined capital fund is found, and 
then the ratio each partner's investment bears to the total is 
ascertained as follows: 

A's Capital $12,000.00 

B's Capital 10,000.00 

C's Capital 15,000.00 

$37,000.00 



PARTNERSHIP FORMATION PROFITS 243 

A's Capital, $12,000.00, bears the ratio to the total $37,000.00 
as twelve bears to thirty-seven; therefore under this method of 
distribution A will receive 12/37 of the total, B 10/37, an d 

c 15/37. 

The following journal entry will divide the profit according to 
the ratio above : 



GENERAL JOURNAL 

Profit and Loss .............. $14,800.00 

A Capital ................ 

B Capital ................ 

C Capital ................ 

To apportion the net profit for 
19 to the partners A, 12/37; 
B, 10/37; C, 15/37. 



$ 4,800.00 
4,000.00 
6,000.00 



After the journal entry above has been posted, the capital 
accounts of the partners will be as follows: 



A CAPITAL 



Balance $12,000.00 

December, %% profit for 
year 4], 800.00 



B CAPITAL 



Balance 
December, 
year 



profit for 



$10,000.00 
4,000.00 



C CAPITAL 



Balance 
December, 
year 



profit for 



$15,000.00 
6,000.00 



The distribution above is based on the capital invested by the 
partners at the beginning of the period; and, should any addi- 
tions of capital or deductions from capital be made during the 
period, these should be recorded in separate drawing accounts. 
It is also an excellent idea, when such an agreement is in force, 
to limit the drawings allowed any one partner. 



244 



FUNDAMENTALS OF ACCOUNTING 



4. AVERAGE CAPITAL RATIO 

When the amounts invested by the partners do not remain 
constant, but fluctuate because of additions or withdrawals of 
capital made during the period, it is more difficult to arrive at 
an equitable basis of profit distribution. By the average capital 
ratio method, the average capital invested by each partner is 
compared to the total average capital of all partners. In using 
this method two elements must be considered : first, the amount, 
and second, the length of time the amount remains invested. In 
doing this, the amounts invested must be brought on to a com- 
mon base such as a day or a month and then the time element 
may be eliminated. 

To illustrate, let us assume the following facts : 

That A's capital account December 31, 19 was as follows: 

A CAPITAL 



July 30 


Withdrawal 


$2,000.00 


June 30 
Sept. 30 


Balance 
Add. Inv. 


$10,000.00 
1,000.00 



B CAPITAL 



Aug. 30 


Withdrawal 


$4,000.00 


June 30 

Nov. 30 


Balance 
Add. Inv. 


$12,000.00 

1,000.00 



From these two capital accounts we may say that A had: 

$10,000 invested for i mo. (June 3o-July 30) i X $10,000 = $10,000 

8,000 invested for 2 mos. (July 3O-Sept. 30) 2 X 8,000 = 16,000 

9,000 invested for 3 mos. (Sept. 3o-Dec. 31) 3 X 9,000 = 27,000 

6 mos. Month Dollars $53,000 

and from B's capital account we may say he had: 

$12,000 invested for 2 mos. (June 3o-Aug. 30) 2 X $12,000 = $24,000 

8,000 invested for 3 mos. (Aug. 3o-Nov. 30) 3 X 8,000 = 24,000 

9,000 invested for i mo. (Nov. 3o-Dec. 31) i X 9,000 = 9,000 

6 mos. Month Dollars $57,000 

As a basis of comparison we shall add the 53,000 month dol- 
lars invested by A to the 57,ooo month dollars invested by B. 
We can now compare A's and B's investments to the total con- 
tributed by both, 110,000 month dollars. 



PARTNERSHIP FORMATION PROFITS 245 

We may say A had 53 ' OO - O of the total or &- 
1 10,000.00 no 



j -r i S7,ooo.oo 57 

and B had -^ - or ~^ L 

110,000.00 no 

If we assume a profit of $5,500.00, 



A should receive: -- X 5>5oo = $2,650.00, and 






B should receive: - X 5,500 = $2,850.00. 

In the distribution above the calculations have been pur- 
posely simplified. The principles involved, however, would re- 
main the same regardless of how complex the problem might be, 
due to any changes in the facts. In actual practice, for example, 
additional investments or withdrawals probably would not be 
made on thfe even date, so that the unit months could not be used 
as a basis. It would be necessary to calculate the number of 
days each investment remained undisturbed, which would 
merely make the resulting fractions larger. Another brief ex- 
ample, using days as a base, is now given. Suppose the fol- 
lowing is the condition of A's and B's Capital accounts on 
December 31, 19 and that they wish $4000.00 to be divided 
according to the average capital investment of each. 

A CAPITAL 



October 4 $2,000.00 



June 30 $10,000.00 



B CAPITAL 



June 30 $12,000.00 

Aug. 7 3,000.00 



From the Capital accounts above we may say that A had: 

$10,000 invested 96 days (June 3o-Oct. 4) 96 X $10,000 = $ 960,000 
8,000 invested 88 days (Oct. 4~Dec. 3i)_88 X 8,000 = 704,000 

days 184 $1,664,000 

This would give A an average investment over the six months of 
($1,664,000-7-184) or $9,043.48. 



246 FUNDAMENTALS OF ACCOUNTING 

And from B's Capital account we may say he had: 

$12,000 invested 38 days(June 3O-Aug. 7) 38 X $12,000 $ 456,000 
15,000 invested 146 days(Aug. y-Dec. 31) 146 X 15,000 = 2,190,000 

days 184 $2,646,000 

This would give B an average investment over the six months of 
(2,646,000 -7- 184) or $14,380.43. 

It would now be possible to compare A's and B's average 
capital to the combined average capital. If we were to do this, 

A would receive: 9 4 ' 34 X $4000, and 
2,342,391 

B would receive: 1*438,043 x $ a 
2,342,391 

However, these are very unwieldy fractions and may be 
avoided by adding the total day dollars invested by A and B 
($1,664,000 + $2,646,000 $4,310,000) and making our com- 
parison on the totals rather than on the daily average. By this 
method (omitting the final three ciphers) : 

A would receive: X $4000 = $1544.32, and 

43 J 

B would receive: - X $4000 = $2455.68. 
43 10 

The principal involved in both cases is the same, the only 
difference being in the longer arithmetical calculation usually 
caused by the larger fraction when days are used instead of 
months. 



5. INTEREST ON CAPITAL INVESTED, BEFORE PROFITS 
ARE DISTRIBUTED 

Sometimes in a partnership, where the capital investments of 
the partners are unequal, an agreement will be made to allow the 
partners a fixed rate of interest on their capital before profits 
are distributed. When this arrangement is in operation, the 
interest is calculated on the amount invested minus the interest 
on any withdrawals. The charge for interest on partners' capi- 
tal is not an ordinary revenue expenditure, such as interest on 
notes payable, but is to be considered as a distribution of part 
of the profits. 



PARTNERSHIP FORMATION PROFITS 247 

After the interest has been allowed, the balance of the profit is 
usually distributed on a fixed ratio. 

For example, let us suppose A, B, and C are partners, and 
have invested respectively $8000.00, $10,000.00 and $12,000.00, 
and they agree that each shall receive 6 per cent per annum on 
his investment, and any further profit or loss is to be distributed 
equally among the partners. 

In carrying out this agreement, let us assume first a profit oi 
$6000.00 at the end of the year. 

The total interest to be paid the partners will amount to 
$1800.00 and the balance $4200.00 will be divided equally. 

The following general journal entries will be required: 

Profit and Loss $1800.00 

A Capital $ 480.00 

B Capital 600.00 

C 'Capital 720.00 

To credit the partners with 6 per 

cent interest on the amount of their 

respective investments. 

Profit and Loss $4200.00 

A Capital $1400.00 

B Capital 1400.00 

C Capital 1400.00 

To credit the partners with equal 

shares of the net profit. 

After these entries have been posted, the Capital accounts 
will appear as follows : 

A CAPITAL 



Jan. 2 Balance 

Dec. 31 Interest 

J profit 



$8,000.00 

480.00 

1,400.00 



B CAPITAL 



Jan. 2 Balance 

Dec. 31 Interest 

J profit 



$10,000.00 

600.00 

1,400.00 



C CAPITAL 



Jan. 2 Balance 

Dec. 31 Interest 

J profit 



$12,000.00 

720.00 

1,400.00 



248 FUNDAMENTALS OF ACCOUNTING 

Let us suppose the facts are the same as in the case above, 
except that the profit before the interest is distributed is only 
$1500.00. The interest will be distributed as before, changing 
the former profit to a loss of $300.00. This loss should now be 
divided equally among the partners as follows : 

A Capital $ 100.00 

B Capital 100.00 

C Capital 100.00 

Profit and Loss $ 300.00 

To charge the partners with the net 
loss for the period. 

It will be noted that, relatively, the partners are treated the 
same in both cases. The interest to be allowed is credited to 
each partner according to the agreement and any balance re- 
maining, or loss resulting, is divided equally. In many in- 
stances, where an agreement to allow interest on partner's 
capital is in operation, the balance will be shared on some other 
arbitrary ratio. For example, let us suppose the same facts as 
before, but that after interest has been divided any profit or 
loss remaining shall be shared A, 30 per cent; B, 50 per cent; 
and C, 20 per cent. 

To carry this arrangement into effect the second journal entry 
would be as follows: 

GENERAL JOURNAL 

Profit and Loss $4200.00 

A Capital $1260.00 

B Capital 2 100.00 

C Capital 840.00 

To divide the $4200.00 profit re- 
maining after interest has been cred- 
ited, A 30 per cent; B 50 per cent, 
and C 20 per cent. 

This sort of agreement will be entered into when the partners 
contribute services, skill, or labor in the partnership organiza- 
tion in varying degrees. 

6. SALARIES AS DIVISION OF PROFITS 

Quite often in the articles of co-partnership the partners will 
mutually agree to permit salaries to be paid as a division of 



PARTNERSHIP FORMATION PROFITS 249 

profits. This arrangement is quite popular in the smaller part- 
nerships, when it is not convenient for the partners to wait until 
the end of the accounting period for their compensation in the 
form of a distribution of profits. They will, therefore, be 
granted a certain salary per week or month, and the balance of 
the profit or loss shared on some other basis. Sometimes a 
salary will be granted to one or more partners, and not to others, 
as a means of compensating such partners for particular services 
rendered the firm, where, for example, one partner runs the en- 
tire partnership business while the others contribute relatively 
no services. 

In every instance, when a salary is granted to partners, such 
arrangement is entirely within the law, and salaries may be paid 
as long as the business is solvent. It must be remembered, how- 
ever, that the salary is a division of the profits; and, should a 
loss result after salaries have been paid, such a loss must be 
borne by the partners on the profit and loss sharing ratio. If 
the firm is insolvent any salaries due partners should be can- 
celed, because, under such circumstances, partners' salaries can- 
not be treated as a firm liability, such as Salaries Due to Em- 
ployees are considered. Assuming the following facts, two cases 
will now be given to illustrate the payment of salary as a divi- 
sion of the profit. Suppose the A-B-C partnership has an agree- 
ment whereby A is to be paid $120.00 a month beside a -J share 
in the remaining profits, B is to receive $300.00 a month beside 
a 3 share in the remaining profits, while C, who is not actively 
engaged in the enterprise, is to share only in the profits, receiv- 
ing the remaining after A and B have received their salaries. 

Case No. i 

Assume a profit of $11,040.00 for the year. A's salary ac- 
count shows a debit balance of $1,440.00 and B's a debit of 
$3600.00. After the two salary accounts are closed, the net 
profit will be $6000.00, which, according to the partnership 
agreement above, will be divided equally, $2000.00 to each. 

Case No. 2 

Let us assume in this case a profit of only $2040.00 for the 
year. 

A's salary account again has a debit of $1440.00 and B's 



250 FUNDAMENTALS OF ACCOUNTING 

$3600.00. Let us further assume the partnership A-B-C is still 
solvent. 

After the two partners' salary accounts have been closed to 
the Profit and Loss account, a debit balance of $3000.00 will 
result, indicating a loss of that amount for the period. 

This loss must now be absorbed by A, B, and C, according 
to their profit and loss sharing ratio. A, B, C's Capital account 
will be charged with $1000.00 each. 

The result of the two cases may now be compared. In the 
first case A would receive $1400.00 as salary and $2000.00 as 
additional profit, $3440.00 in all. In the second case the debit 
to his Capital account of $1000.00 would reduce the amount 
of $1440.00 he received as salary to $440.00. 

B, in the first case, would receive $3600.00 as salary and 
$2000.00 his 3 share of the profits. In the second case the 
debit of $1000.00 to his Capital account would reduce his net 
income to $2600.00. 

C, in the first case, receiving no salary, would receive only 
$2000.00 his share of the profits. In the second case, again, 
he receives no salary, but does participate in the resulting net 
loss. His Capital account would therefore be decreased by 
$1000.00, his share of the loss. 

It is hoped it will be evident from these cases that partners 7 
salaries must be construed as a division of the profit for the 
period. They should not be considered with the ordinary ex- 
penses of running a business, even though the services rendered 
by a partner would be performed by a paid executive. 

Very often, in an attempt to justify partners' salaries as one 
of the regular expenses of carrying on the partnership business, 
partners will advance the argument that if the partners did not 
serve in their respective capacities, hired executives or em- 
ployees would, and if the latters' salaries are legitimate operat- 
ing costs, so should identical services rendered by partners 
result in legitimate operating costs. 

The unsoundnes.s of such reasoning should be evident to the 
thoughtful reader; but, regardless of how one feels on this mat- 
ter, the law is unquestionably against permitting such a practice. 



PARTNERSHIP FORMATION PROFITS 2 5 1 

7. COMBINATION OF METHODS 

In some instances it will be desirable to combine two or more 
of the foregoing methods. As a combination would be made to 
meet individual special circumstances, no hypothetical cases 
need be considered. 

PARTNERS' DRAWING, SALARY, AND LOAN ACCOUNTS 
DIFFERENTIATED 

A. Partners' Drawing Accounts. Partners may be permitted 
in the articles of co-partnership to make regular withdrawals 
against anticipated profits, or be paid a certain sum as salaries. 
In either case a Drawing or Personal account should be estab- 
lished for each partner. This account should be used to record 
all temporary fluctuations in the partner's capital. As a rule, 
a partner may not draw funds from the partnership against his 
original investment, without consent of the other members of 
the firm. This is a point which should be covered in the part- 
nership agreement. 

Current profits are usually credited to the partners' Drawing 
or Personal accounts. If drawings have been judiciously taken, 
the credits should offset the drawings and leave a credit ex- 
cess. This favorable balance may be closed to the partners' 
Capital accounts, or be allowed to remain as a credit against 
subsequent drawings. Should a partner draw in any period an 
amount greater than his share of the profits, then a problem 
arises, what to do with the debit balance? It may be closed 
to the partners' Capital account, reducing his investment, or if 
the partners do not wish to have their original investments 
changed, then this debit balance may be permitted to stay in the 
Drawing account. Subsequent credits from profits may balance 
it, or the partner may be required to make a contribution to 
close this unfavorable debit balance. Every set of agreements 
for a partnership should be specific on the point of drawings, 
and such agreements should be specific in setting a limit to the 
partners' drawing so as to prevent any partner from impairing 
the firm's capital. When such an agreement is in force, the 
accountant should be careful to see that its terms are not 
violated. 

Another use often made of the partners' drawing account 



252 FUNDAMENTALS OF ACCOUNTING 

is to record withdrawals of merchandise for personal use. These 
withdrawals are usually made at cost. 

B. Partners' Loan Accounts. In some articles of co-partner- 
ship, arrangements will be included to treat as Partnership Loans 
certain money advanced by a partner in excess of his agreed 
contribution. Such loans are treated as Loans Payable, and 
usually carry with them interest, which must be paid before 
profits are distributed, just as interest on any other firm liability. 
This arrangement, like partners' salaries, is wholly within the 
law just as long as the business is solvent; but, should the busi- 
ness fail, then partners' loans, in the eyes of the law, will be 
treated as all other capital contributions, merged to meet the 
firm's liabilities. As between the partners themselves, how- 
ever, interest on partners 7 loans must be paid, even if the pay- 
ment results in a net loss. Such a loss would be treated as any 
other loss, charged against the partners' Capital accounts on the 
agreed profit and loss sharing ratio. 

As we shall see under the topic " Dissolution," as between the 
partners, a Loan account has precedence over partners' Capital 
accounts and must be liquidated in full before any dividend is 
granted to the partners for Capital. 



QUESTIONS ON THE CHAPTER 

1. List the principal advantages and disadvantages of the three 
major forms of business organization. 

2. Why are the Articles of Co-Partnership so necessary in the 
formation of a partnership? 

3. What law now governs partnerships in New York and New 
Jersey? Has this law been adopted by the majority of States in the 
Union? 

4. Define a partnership. What are the elements of the definition? 

5. What effect has the death of a partner on the continuation of 
the partnership business? Does it dissolve or discontinue the part- 
nership? 

6. List ten important clauses you would like to see incorporated 
in a model partnership agreement. 

7. In a partnership formed to carry on the ordinary mercantile 
business can one partner sell the firm's real estate? Can he sell the 
entire stock of merchandise? Can he bind the partnership and his 
other partners to pay for the merchandise which he selects and pur- 
chases without consulting them? 

8. What do you think are the principal defects of the partnership 



PARTNERSHIP FORMATION PROFITS 2 53 

form of organization? Under what circumstances would you advo- 
cate the formation of a partnership? And under what circumstances 
would you advise against forming a partnership? What type of or- 
ganization would you suggest? Why? 

9. Outline in brief the journal entries required to start a partner- 
ship. 

ro. May the executor of a deceased partner demand admission to 
the partnership, in order to see that the share in the business due the 
estate is properly safeguarded? Why? 

n. What is the attitude the courts would take regarding the dis- 
tribution of profits in a case between A whose Capital investment is 
$10,000.00 and B whose investment is $2000.00 in the A and B part- 
nership? 

(a) Providing there is no clause on this subject in the articles 
of co-partnership? 

(b) Providing a clause in the partnership agreement provides 
A is to receive 30 per cent and B 70 per cent of all profits and losses? 

12. Enumerate and briefly describe six different methods in use to- 
day to distribute partnership profits. 

13. A, B, and C are forming a partnership. A agrees to contribute 
$8000.00; B agrees to contribute $6000.00; and C agrees to contrib- 
ute $10,000.00. 

A further agrees to act as traveling salesman for the new firm, cov- 
ering a broad territory; B is to take full charge of the management 
of the enterprise except the selling; C, an attorney, will do legal work, 
only when required by the partnership. 

Assuming the foregoing facts, write a paragraph describing the dis- 
tribution of profits and earnings which you would suggest be incorpo- 
rated in the articles of co-partnership. Be brief, but clear on each 
point. 



PROBLEM MATERIAL 

PROBLEM i 

J. Cooke has operated a lumber yard as a sole proprietor for several 
years, and now wishes to expand his business. He invites H. Davis 
and C. Emory to join him as partners. 

A certified public accountant has just completed an audit of the 
books of record of Mr. Cooke's lumber yard, which reveals the follow- 
ing condition. 



254 



FUNDAMENTALS OF ACCOUNTING 



COOKE LUMBER Co. 
Balance Sheet as of October 15 



Assets 
Cash in Bank 
Cash on hand 
Accounts Receivable 
Less Reserve 

Inventory 
Mortgages Receivable 
Machinery & Equip. 
Less Reserve 

Delivery Trucks 
Less Reserve 

Land 
Buildings & Sheds 
Less Reserve 

Total Assets 


$76,715.60 
1,441.47 


$ 6,600.80 
125.00 

75,274.13 

44,300.07 
6,000.00 

12,000.00 

6,720.00 
6,000.00 

22,560,00 


Liabilities 
Accounts Payable 
Notes Payable 
Mortgage Payable 
Wages Payable 
Taxes Payable 
Total Liabilities 

Net Worth 
Mr. J. Cooke 

Total Liab. &N. W. 


$ 51,820.00 

12,000.00 

15,000.00 
360.00 
1,200.00 


$20,000.00 
8,000.00 


$ 80,380.00 
$ 99,200.00 


8,400.00 
1,680.00 


$24,000.00 
1,440.00 




$179,580.00 


$179,580.00 



Mr. Davis and Mr. Emory are satisfied with the audit and accept 
the balance sheet prepared by the public accountant as the basis for 
their partnership which is to be known as the Cooke Lumber Com- 
pany. Mr. Davis agrees to invest an amount of cash sufficient to 
make him a one-quarter owner, while Mr. Emory agrees to invest 
cash sufficient to give him a one-eighth interest in the new business. 

Required: Assuming the partnership agreement is ratified and signed 
by all three members, write the entries required to place the names 
and investments of the new partners on the books, provided the old 
books are to be continued in use. 



PROBLEM 2 

H. Stowe has operated a wholesale provision business for some 
years and has at December 31, 19 the following accounts: Accounts 
Receivable net of doubtful accounts $42,641.00; Inventory of Provi- 
sions $26,419.00; Delivery Trucks which cost $16,000.00, against 
which there was a Reserve for Depreciation of $4200.00; Fixtures 
and Equipment cost $7200.00, against which was a Reserve for De- 
preciation of $2400.00; Notes Payable totaled $12,000.00, while Ac- 
counts Payable amounted to $38,720.00. 

G. Thomas has also been in the wholesale provision market, and 
has at December 31, 19 the following accounts: Inventory $26,- 
125.00; Land and Buildings $40,000.00, against which there is a 
mortgage payable of $20,000.00 and a Reserve for Depreciation of 



PARTNERSHIP FORMATION PROFITS 2 5 5 

$14,000.00; Fixtures cost $20,000.00, but against which there was a 
Reserve for Depreciation of $16,000.00; Delivery Equipment cost 
$22,000.00 and had a companion Reserve for Depreciation of $12,- 
ooo.oo ; Accounts Payable totaled $30,625.00, while Notes Payable 
amounted to $10,000.00; Accounts Receivable net of bad debts were 
valued at $22,640.00. 

Both men have, with the aid of certified public accountants, exam- 
ined each other's accounts, and accept the values above as a basis for 
the formation of a partnership. The new firm is to bear the name of 
" The Stowe Thomas Provision Co.," and the partners agree to in- 
vest, in addition to the foregoing accounts, sufficient cash to make 
them equal partners with net investments of $40,000.00 each. 

Required: 

( i ) How much cash must each partner invest? 

(2) Draft the opening journal entries, under date of January 2, 
19. 

(3) Prepare a balance sheet for the partnership as of January 2, 



PROBLEM 3 

Assume the Cooke Lumber Company mentioned in Problem i has 
just completed the first year's business as a partnership, and that the 
audited financial statements reveal a net profit of $16,800.00. 

(1) How should this profit be divided, supposing the articles of 
co-partnership were silent regarding profit sharing? 

(2) Write the journal entries required to close the Profit and Loss 
Summary account which has a credit balance of $16,800.00, 
provided the partners share profits in accordance with their 
capital at the start of the partnership. 

PROBLEM 4 
Assume the Capital accounts of three partners are as follows: 

B. LEONARD 



Mar. 30 2000.00 



Jan. i Bal. 6400.00 



C. MUNSON 



Jan. i Bal. 4000.00 

June 30 2500.00 



D. NICHOLS 

May 31 2000.00 Jan. i Bal. 8000.00 

Nov. i 2000.00 



256 FUNDAMENTALS OF ACCOUNTING 

Required: At December 31 there is a profit of $9990.00 which is to be 
divided according to the average capital invested. 

How much should each partner receive? Show your calcula- 
tions. 

PROBLEM 5 
Assume the following Capital accounts: 

B. OLDFIELD 



June 30 2,000.00 



Jan. Bal- 10,000,00 



T. MURPHY 



Jan. i Bal. 4000.00 

Mar. i 1000.00 



The partnership agreement states that each partner shall be cred- 
ited with 6% interest per annum for all monies invested and charged 
the same rate for all withdrawals. The balance of any profits or 
losses to be shared equally. 

(a) Assume a profit for the year of $6450.00. 

(b) Assume a profit for the year of $500.00. 

(c) Assume a loss for the year of $370.00. 

Required: Journal entries to distribute interest, gains, or losses in each 
case. 



CHAPTER XV 

PARTNERSHIPS ADMISSION OF A NEW 
PARTNER AND DISSOLUTION 

ADMISSION OF A NEW PARTNER: INTRODUCTION 

The last chapter treated the organization of partnerships and 
the division of profits and losses. This chapter will treat the 
problems raised when a new partner is admitted, and the pro- 
cedure in the dissolution or winding up of the partnership af- 
fairs, together with associated problems. 

According to the law of partnership, when a new partner is 
admitted to an already existing partnership, the old firm is dis- 
solved and a new firm organized. This is true even though the 
affairs of the old partnership are to be taken over by the new 
firm and, as a matter of fact, no changes contemplated. Tech- 
nically, the admission of a new partner automatically dissolves 
the old organization, and it is necessary that a new organization 
be formed. This is true because of the very nature of partner- 
ships themselves. A new partner cannot be brought into an al- 
ready existing firm without the mutual consent of all the old 
partners. The usual procedure is to draw up a new set of arti- 
cles of co-partnership or write an amendment to the old articles 
which must be signed by all the old members and the new 
members. 

In either case care must be taken, in writing the articles of 
co-partnership, to show clearly the rights of all partners, rela- 
tive to the new profit and loss sharing ratio; the amount of capi- 
tal the new partners are to contribute; and how this capital is 
to be handled. All these points will be more fully discussed in 
this chapter. 

One of the problems which must be settled when a partner is 
being admitted, either by a sole proprietor or by an already 
existing partnership, is that of the proper valuation of the assets 
of the business to which the new partner contemplates admis- 
sion. A clear understanding on this point by the old and new 
members is very important. A balance sheet taken from the 
books of the old firm will show the book value of all assets and 
the net worth of the old firm. This value may be more or less 

257 



258 



FUNDAMENTALS OF ACCOUNTING 



than the real value of the business. If the business is prospering 
and making a good profit, quite likely it will be valued at a great 
deal more than the net worth; and, similarly, should the busi- 
ness be in poor shape, the net worth ascribed to it by the balance 
sheet may greatly overestimate the true value of the business. 
This usually requires a revaluation of all the assets and the 
measurement of good-will, if such an asset is to be added. All 
these points should be carefully studied and included in the 
agreement admitting the new partner. 

Probably the best way to bring out these various problems is 
by a series of cases involving different important points to be 
observed when a new partner is admitted. 

Case No. i 

Suppose A and B, who have conducted the A and B partner- 
ship for three years, wish to expand their business, and invite 
C to join them as a partner. 

The following balance sheet taken from the books of the A 
and B partnership as of December 31 is presented to C as a 
basis for consideration. 



A AND B 

Balance Sheet as of December 3 1 



Cash 
Accounts Receivable 
Notes Receivable 
Inventory 
Land and Buildings 
Office Equipment 


$ 3,200.00 
14,600.00 
3,000.00 
16,000.00 

20,000.00 

2,400.00 


Total Sundry Liabilities 
(details omitted) 
A Capital 
B Capital 


$29,200.00 
15,000.00 
15,000.00 


$59,200.00 


$59,200.00 



A. Purchase of an Interest, Cash to Remain in the Business. 
C is satisfied that the assets are correctly valued and wishes to 
purchase a one-third interest in the business by making a cash 
investment of $15,000.00, which is to be used by the business in 
its expansion. 

The only journal entry required at this time (after the new 
organization is completed) will be: 

Cash $15,000.00 

C Capital $15,000.00 



ADMISSION OF PARTNER 



259 



When this entry is posted, the three capital accounts will be 
equal, each $15,000.00, and C will have a one-third interest in 
the business. 

B. Purchase of an Interest, Cash to Partner or Partners as Per- 
sonal Consideration. Assume, in this instance, that A and B 
agree to admit C as an equal partner and sell C a one-third 
share in the business for $10,000.00, but the purchase price they 
receive is to be divided equally between them personally and not 
to go into the partnership at all. 

The net worth of the business according to the balance sheet 
in Case No. i is $30,000.00; therefore, if C is to own a one 
third interest in the business, his account will have to be credited 
with one third of the net worth or $10,000.00, while A's and B ? s 
capital accounts will have to be debited each with $5000.00. 

The journal will be as follows : 



GENERAL JOURNAL 

A Capital $ 5,000.00 

B Capital 5,000.00 

C Capital $10,000.00 

To record the sale of a one-third 
interest in the A and B partner- 
ship, as per new partnership 
agreement. 

When this journal entry has been posted, the partners' capital 
accounts will appear as follows: 

A CAPITAL 



Jan. 2 To adjust as per 
agreement 



$5,000.00 



Dec. 31 Balance 



$15,000.00 



B CAPITAL 



Jan. 2 To adjust as per 
agreement 



$5,000.00 



Dec. 31 Balance 



$15,000.00 



C CAPITAL 



Jan. 2 ^ interest in 

A-B-C partner- 
ship $10,000.00 



260 



FUNDAMENTALS OF ACCOUNTING 



Case No. 2 

We shall again use the same balance sheet as in Case No. i ; 
but assume the business has been losing money, and, although 
solvent, the values ascribed to the assets are too high, according 
to Cs accountants who have made a careful audit and ex- 
amination. 

C's accountants present the following balance sheet as more 
accurately valuing the assets owned by A and B. 

A AND B 

Balance Sheet as of December 31 



A ssets 




Liabilities 




Cash 


$ 3,200.00 


As before, details omitted 


$29,200.00 


Accounts Receivable 








(less allowance for bad 








debts) ^ 


10,000.00 






Notes Receivable 


3,000.00 






Inventory 








Cost less unsalable prod- 








uct rejected 


12,000.00 


Net Worth 




Land & Buildings 


15,000.00 


A Capital 


8,000.00 


Office Equipment 


2,000.00 


B Capital 


8,000.00 




$45,200.00 




$45,200.00 



On this valuation C offers A and B $8000.00 for a one-third 
share in the new business, providing the $8000.00 contributed 
stays in the business and that the assets be revalued as in the 
preceding balance sheet. 

Assuming A and B agree, the following journal entries will 
be required: 



GENERAL JOURNAL 

-i 

A Capital $7000.00 

B Capital 7000.00 

Reserve for Doubtful Accounts . 

Inventory 

Land & Buildings 

Office Equipment 

To revalue assets as per new partner- 
ship agreement. 



$4600.00 

4000.00 

5000.00 

400.00 



ADMISSION OF PARTNER 



261 



-2- 

Cash $8000.00 

C Capital $8000.00 

To record receipt of cash from C for 
a one-third share in the new partner- 
ship as per agreement. 

When the journal entries above have been posted, the three 
partners' capital accounts will appear as follows: 

A CAPITAL 



Jan. 2 


To charge for re- 
valuation as per 
agreement 


$7,000.00 
B C 


Dec. 31 Balance 

APITAL 


$15,000.00 


Jan. 2 


To charge for re- 
valuation as per 
agreement 


$7,000.00 
C C 


Dec. 31 Balance 

APITAL 


$15,000.00 



Jan. 2 For a J interest in 
the "A-B-C" 
partnership $8,000.00 



Case No. 3 

The same balance sheet as used in Case No. i is again em- 
ployed. This time let us assume that A and B, in offering C a 
one-third share in the partnership, believe that, while the assets 
on the balance sheet reflect the correct valuation, another asset 
in the form of good-will should be added before the one-third 
share is figured. A and B believe that, during the three years 
the business has been in operation, they have built a very fine 
reputation; and, because of their increasing sales together with 
a profit of five per cent above the average in their line of busi- 
ness, a value should be placed on the good-will. 



GOOD-WILL IN PARTNERSHIP 



When a partner is being admitted it will be often necessary to 
calculate a value for good-will, just as it is also sometimes re- 
quired when a member is withdrawing from a firm, or if a part- 



262 



FUNDAMENTALS OF ACCOUNTING 



ner dies. A great deal has been written about good-will and a 
further comment will appear in this text in a subsequent chap- 
ter; but, except as we are immediately concerned, no lengthy, 
theoretical discussion shall be entered into at this time. Let us 
assume, for brevity's sake, that the old partners have proposed 
an allowance of $4425.00 for good-will, and C, the new partner, 
accepts this figure. Two possible methods of treatment will 
give two rather different results. 

A. Good-will Treated as an Asset to be Added before New 
Partner is Admitted. In this case A, B, and C mutually agree 
that the value of good-will, $4425.00, shall be first written onto 
the books and divided equally between A and B, and that C 
shall pay into the new business cash equal to A's and B ? s capital 
investments. The following Journal entries will carry out this 
arrangement. 

GENERAL JOURNAL 

Good-will $ 4,425.00 

A Capital $ 2,212.50 

B Capital 2,212.50 

To record the asset Good-will and 

its distribution equally between 

A and B. 

-2- 

Cash 17,212.50 

C Capital 17,212.50 

To record the receipt of cash 
from C as his payment for a - in- 
terest in the new partnership. 

A balance sheet taken from the ledger of the A-B-C part- 
nership after the two Journal entries above have been posted 
would look as follows : 

A-B-C 

Balance Sheet as of January 2 



Cash 


$20,412.50 


Total sundry liabilities 




Accounts Receivable 


14,600.00 


(details omitted) 


$29,200.00 


Notes Receivable 


3,000.00 






Inventory 


16,000.00 






Land and Buildings 


20,000.00 


A Capital 


17,212.50 


Office Equipment 


2,400.00 


B Capital 


17,212.50 


Good-will 


4,425.00 


C Capital 


17,212.50 




$80,837-50 




$80,837.50- 



ADMISSION OF PARTNER 



263 



B. Good-will Divided Between Partners as a Personal Con- 
sideration. In this treatment A and B feel that they have been 
instrumental in building up the good-will and that this amount 
should be paid to them as a personal consideration, aside from 
the amount C must pay into the firm for his membership. As- 
sume that C agrees to this condition (which will cost him more), 
then on the books of the partnership the only entry required 
would be : 

GENERAL JOURNAL 

Cash $15,000.00 

C Capital $15,000.00 

To record the receipt of $15,- 
ooo.oo from C as his contribu- 
tion to the business for a $ 
interest. 

When this journal entry has been posted, the three capital 
accounts will be equal, each having a credit of $15,000.00. 

Under these circumstances C would pay the agreed amount 
$4425.00 to A and B as a personal consideration, and of course 
no records would be required on the books of the partnership. 

It will be noted that the amount paid by C for good-will, as 
part of the cost of his share in the new partnership, does not 
appear on the new balance sheet which is illustrated below. 

A-B-C 

Balance Sheet as of January 2, 19 



Cash 


$18,200.00 


Total Sundry Liabilities 




Accounts Receivable 


14,600.00 


(details omitted) 


$29,200.00 


Notes Receivable 


3,000.00 






Inventory 


16,000.00 


A Capital 


15,000.00 


Land and Buildings 


20,000.00 


B Capital 


15,000.00 


Office Equipment 


2,400.00 


C Capital 


15,000.00 




$74,200.00 




$74,200.00 



DISSOLUTION AND TERMINATION 

The Uniform Partnership Act, Section 29, defines dissolution 
as ". . . the change in the relation of the partners caused by 
any partner ceasing to be associated in the carrying on, as dis- 
tinguished from the winding up of, the business/' And by the 
following article, Section 30, Uniform Partnership Act, we note 



264 FUNDAMENTALS OF ACCOUNTING 

that termination goes further than dissolution and includes the 
winding up and settlement of the partnership affairs. 

There are many ways in which a partnership may be dissolved. 
However, we shall concern ourselves with only a few of the more 
important cases. 

I. EXPIRATION OF AGREED TERM 

If the articles of co-partnership are properly drawn, a clause 
on the subject of dissolution should be included. 

If a partnership is formed for a definite period, then at the 
close of that period the firm is automatically dissolved. How- 
ever, the partners may agree to continue. Under these circum- 
stances no accounting is required. 

Should the partners decide not to continue, the problem of 
winding up the affairs of the partnership must be tackled. 

When such a decision is reached, usually one partner will be 
appointed liquidating partner. He will publish notice of the 
liquidation in the leading newspapers and give notice to credi- 
tors. He will carry on the business only as far as it is necessary 
to liquidate the affairs of the partnership. This will include 
only the purchases necessary to complete contracts, and to com- 
plete partly finished goods. His most important duties will be 
the actual liquidation of the business. 

The usual procedure is for the liquidating partner to sell 
the assets and pay the firm's liabilities. Any proceeds remain- 
ing will be used to pay the partners' claims. 

The liquidator must be careful in liquidating, particularly if 
there is any likelihood that there will not be sufficient funds 
from the sale of the assets to pay all the liabilities in full. He 
must be guided by the following rules as outlined in the Uni- 
form Partnership Act, Section 40; New York Partnership Law, 
Section 7 1 , which is quoted in part : 

RULES AS TO SETTLING ACCOUNTS AFTER DISSOLUTION 

" In settling accounts between the partners after dissolution, the 
following rules shall be observed, subject to any agreement to the 
contrary: 

(a) The assets of the partnership are: 
I. The partnership property. 
II. The contributions of the partners necessary for the payment 



DISSOLUTION 265 

of all liabilities specified in paragraph (b) of this sub- 
division. 

(b) The liabilities of the partnership shall rank in order of pay- 
ment as follows : 

I. Those owing to creditors other than partners. 
II. Those owing to partners other than for capital and profits. 

III. Those owing to partners in respect of capital. 

IV. Those owing to partners in respect of profit. . . ." 

A study of the rules above makes it clear that " liabilities " 
must be paid first and in full before anything may be paid to the 
partners, (b) II above means that partners' loans and interest 
should next be paid and in full to the partners having such loan 
accounts before the partners receive their capital investments 
as indicated in (b) III. 

When a partnership is liquidated, there is usually some good 
reason for. liquidating, and step (b) IV above is not ordinarily 
reached; however, should there be a profit on the liquidation, 
then, of course, it will be paid to the partners on the profit and 
loss ratio, like any other profit. 

The more usual cases in partnership dissolutions will not yield 
sufficient funds to pay all the partnership claims. If a partner- 
ship contemplates liquidation and can see that the assets will 
not yield enough to pay the liabilities in full, as in (b) I above, 
and if the partners have no personal estates with which to pay 
any deficiency, then it will pay them to have their attorney file 
a voluntary petition in bankruptcy. In this case a receiver will 
be appointed by the court to liquidate the business and the 
partners in due course will all receive discharges in bankruptcy. 
If, on the other hand, any partner has a personal estate which 
could pay the creditors any deficiency resulting from the sale of 
the partnership assets, then it will probably pay that partner 
to liquidate the business himself, and save the expenses of a re- 
ceivership; for, if a receiver is appointed, he will assess any 
partner who has funds to pay a deficiency to the creditors. 

If one of the partners liquidates a business, and, after paying 
the outside creditors in full, has not sufficient funds to pay the 
partners in full, then there must have been a loss on liquidation. 
This loss on liquidation should be charged to the partners' capi- 
tal accounts just like any other loss, as per the partnership agree- 
ment; or, in absence of an agreement, the loss must be shared 
equally. After this loss has been charged to the partners, the 



266 



FUNDAMENTALS OF ACCOUNTING 



total balances in the partners 7 accounts will equal the cash avail- 
able for distribution ; and the final step of liquidation will divide 
these funds among the partners, in accordance with their ad- 
justed balances. 

Case No. i 

LIQUIDATION OF PARTNERSHIP VOLUNTARY AGREEMENT 

A and B have been partners. The term of their partnership 
has expired and they mutually agree to dissolve. A is to con- 
tinue the business only as long as is necessary to fill outstanding 
orders and immediately is to proceed to sell the assets and pay 
off the firm's liabilities, and to wind up the partnership affairs. 
The following is the balance sheet of the A-B partnership as 
of February 15, 19 , the date of termination. 



A-B 

Balance Sheeet as of February 15, 19 



'4s 
$ 2,462.00 
3,000.00 
8,245.00 
ry 3,140.00 
1,000.00 
1,800.00 
240.00 


Liabilities 
Notes Payable 
Accounts Payable 
Total Liabilities 

Net Worth 
A Capital 
B Capital 


$ 5,000.00 
7,887.00 


12,887.00 

4,280.00 
2,720.00 


$19,887.00 


$19,887.00 



Cash 

Notes Receivable 
Accounts Receivable 
Merchandise Inventory 
Oflice Equipment 
Delivery Truck 
Sundry Assets 



At March isth A has completed the liquidation of the busi- 
ness. The assets, exclusive of cash, sold for $13,938.00, while 
$343.00 was expended in necessary expenses of liquidation. 
The firm's liabilities, together with the expenses of liquidation, 
have been paid in full, and A has left $3170.00. The net loss 
on liquidation is $3830.00 and this will be distributed on the 
profit and loss sharing ratio, which in this case, let us assume, is 
60% to A and 40% to B. 

The following would be the journal entries to give effect to 
all the steps above in the complete liquidation of the business: 



DISSOLUTION 267 

GENERAL JOURNAL 

-i 

Cash ....................... $13,938.00 

Loss on Liquidation .......... 3,487.00 

Notes Receivable .......... $ 3,000.00 

Accounts Receivable ....... 8,245.00 

Merchandise Inventory ..... 3,140.00 

Office Equipment .......... 1,000.00 

Delivery Truck ............ 1,800.00 

Sundry Assets ............. 240.00 

To record the sale of assets and 

the resulting loss on liquidation. 

_ r* 

Notes Payable .............. 5,000.00 

Accounts Payable ............ 7,887.00 

Cash ..................... 12,887.00 

To record the payment in full of 
all liabilities. 

-3- 
Loss on Liquidation .......... 343 -oo 

Cash ..................... 343-00 

To record the expenses of liqui- 
dation paid in full. 

After these entries have been posted a trial balance would 
reveal the following condition : 

Cash ....................... $ 3,170.00 

Loss on Liquidation .......... 3,830.00 

A Capital Account ........... $ 4,280.00 

B Capital Account 



______ __. 

$ 7,000.00 $ 7,000.00 

The next journal entry will distribute the loss on liquidation 
according to the profit and loss sharing ratio. 

-4- 

A Capital .................. $ 2,298.00 

B Capital .................. 1,532.00 

Loss on Liquidation ........ $ 3,830.00 

To distribute above loss 60% to 
A and 40% to B. 

The following journal entry will record the payment of the 
partners' balances: 



268 FUNDAMENTALS OF ACCOUNTING 

-5- 

A Capital 1,982.00 

H Capital i, 188.00 

Cash 3,170.00 

To record the payment of the re- 
maining cosh to the partners, 
closing the cash account and 
capital accounts of the partners. 

After these entries have been posted, all accounts of the part- 
nership will have been closed and the business completely 
liquidated. 

DEATH OF A PARTNER 

The death of any partner automatically dissolves the partner- 
ship. The surviving partners may decide to liquidate the af- 
fairs of the partnership or they may decide to continue the old 
organization. If dissolution is decided upon, the same procedure 
as illustrated above will be carried out. Very often the articles 
of co-partnership will be specific on this question and outline 
the procedure in case of dissolution or continuation of the busi- 
ness. Usually some agreement will be made to permit the sur- 
viving partners the right to continue the business, paying the 
deceased's share in the old partnership to his estate in several in- 
stallments. This clause is inserted to prevent the possible de- 
struction of a profitable enterprise, which might be destroyed 
or hurt if any one partner's entire share had to be paid at one 
time. Sometimes a provision is also included requiring a re- 
valuation of assets, particularly good-will, so that the deceased's 
estate may receive its just part of the good-will which was built 
up during the deceased partner's lifetime. 

Case No. 2 

DEATH OF A PARTNER, SURVIVING PARTNERS CONTINUE 

Suppose A, B, and C, who conduct the A-B-C wholesale hard- 
ware business, have agreed in the articles of co-partnership, 
u That in case of the death of any partner, the surviving part- 
ners may continue the business by paying to the estate of the 
deceased in three equal installments, the first 30 days after 
death, the second 90 days after death and the balance six months 
after death the book value of the deceased partner's share in 



DISSOLUTION 



269 



the business at the time of his death. This share is to be cal- 
culated as follows: the balance in his capital account plus any 
profits or minus any losses, which may be determined by the 
proper financial statements prepared as of the date of deceased 
partner's death. Xo revaluation of assets shall be made except 
to add good-will if such an asset exists, and to be calculated as 
follows. Considering ten per cent as a fair return on the capital 
invested, should any excess be earned, such excess shall be aver- 
aged over the three years last preceding the death of a partner. 
This average excess profit shall then be multiplied by five, to 
determine the value of good-will. This asset shall be added to 
the records and its value distributed to all partners according 
to their capital ratio, including the deceased partner's account." 
Profits and losses are also shared on the capital ratio. 

A dies and a balance sheet taken as of the date of his death 
reveals the following financial condition: 

A-B-C HARDWARE STORE 
Balance Sheet as of February 17, 1940. 



Sundry assets, details 
omitted 



$70,000.00 



$70,000.00 



Sundry liabilities, details 

omitted 
A Capital 
H Capital 
C Capital 
Net profit for period 

Dec. 31, JQ % $O to Feb. 17 

1940, as per P. & L. State 

mcnt 



$2K,Koo oo 
1 0,000 oo 

I 2,000 OO 

i,H f ooo.oo 



1,200.00 
$70,000.00 



Capital invested: 

$ 35,000.00 
42,000.00 
^40.000.00 
$i 17,000.00 



Average capital . . $ 39,000.00 



The profits for 

1937 were $ 7,200.00 

1938 were 8,400.00 

1939 were 8,700.00 

$24,300.00 
Average profit .... $ 8,100.00 

The average profits of $8100.00 exceed ten per cent of capi- 
tal investment ($3900.00) by $4200.00. This amount multi- 
plied by five equals $21,000.00, the value which should be 
placed on the firm's good-will. 

This amount should be placed on the firm's books by a Jour- 
nal entry crediting each partner with his proper share as per the 
partnership agreement. 



270 FUNDAMENTALS OF ACCOUNTING 

GENERAL JOURNAL 



Good-will $2 1,000.00 

A Capital Account $ 5,250.00 

H Capital Account 6,300.00 

C Capital Account 9,450.00 

To set up the good-will computed 
at death of A, and distribute it to 
each of the partners in the capi- 
tal ratio, in accordance with the 
partnership agreement. 

2 

Profit and Loss $ 1,200.00 

A Capital $ 300.00 

B Capital 360.00 

C Capital 540.00 

To distribute the profit from 

Dec. 1939 to Feb. 1940 to the 

partners in the capital ratio. 

After these entries have been posted, A's capital account will 
appear as follows: 

A CAPITVL 



Hiil. Dec. 31, 1 030 $10,000.00 

Add i of Profit to Feb. 17, 

iQ4o 300.00 

Add \ of good-will 5,250.00 

B and C agree to purchase A's share and continue the business 
by paying to A's estate $15,550.00 as above calculated; giving 
to A's estate three notes, the first $5183.33, due March 19, 1940, 
the second $5183.33, due May 18, 1940, and the third $5183.34, 
due August 17, 1940. The administrator of A's estate agrees 
and the affairs of the old partnership are closed. B and C form 
a new organization, setting up the liability due A's estate as 
Xotcs Payable, after which the following balance sheet is 
prepared. 



DISSOLUTION 

B-C 
Balance Sheet as of Feb. 18, 1938 



271 



Assets 




Liabilities 




Sundry (detail omitted) $70,000.00 
Good-will 21,000.00 


Sundry (detail 
Notes Payable 
"A" 


omitted) 
to Estate of 


$28,080.00 
15,550.00 




Total Liabilities 


$44,350.00 




Net Worth 




B Capital 
C Capital 




18,66000 

27,t)QO.OO 

$q i ,000 oo 


$91,000.00 



The student will observe from the balance sheet above that 
the notes given to the executors of the estate of A have been 
shown as liabilities of the new partnership, and these will be 
paid off as per the agreement. This arrangement is entirely in 
conformity with partnership law just as long as the former 
creditor's rights are safeguarded. But any retiring partner (or 
deceased partner's estate), while not liable for future debts of 
the new partnership, is truly a guarantor of payment of the old 
debts. 

Several other causes may result in the dissolution of a part- 
nership, beside the few reviewed. The majority of these rea- 
sons are highly technical and involve an understanding of the 
law of partnership and affiliated subjects; for instance, such 
causes as the misconduct of a partner, the insanity of a partner, 
or bankruptcy of a partner or of the firm. In all these cases the 
partnership, if not automatically dissolved by law, is subject to 
dissolution by any member desiring dissolution. For further 
information the student should refer to any standard work on 
the law of partnership. The accounting technique involved 
would follow lines similar to those already outlined. 



LIMITED PARTNERSHIP 



Most states today have adopted the Uniform Limited Part- 
nership Act, or have statutes of a similar nature. To establish a 
limited partnership all the requirements of the law must be com- 
plied with. The partnership agreement must be sworn to by the 
general and special or limited partners and must usually be filed 



272 FUNDAMENTALS OF ACCOUNTING 

in the office of the County Clerk, where the partnership's prin- 
cipal office is to be located. The certificate must state among 
other things : 

(a) Name and address of the partnership. (The name of the lim- 
ited partners cannot be used in the firm name.) 

(b) Names and addresses of all general and limited partners. 

(c) The contributions of the limited partner. 

(d) The nature and life of the partnership. 

In every limited partnership there must be at least one gen- 
eral partner. The general partners control and manage the 
business. The limited partners to be limited must be silent. 
Accounting for the limited partnership is very much the same 
as that required for the regular form of partnership. 



QUESTIONS ON THE CHAPTER 

1. Does the death of a partner always result in a dissolution of the 
partnership? 

2. Differentiate between dissolution and termination of a part- 
nership. 

3. May the executor or the administrator of a deceased partner's 
estate demand membership in the partnership, in order to see that the 
share of the deceased partner is fully protected? 

4. Outline briefly the application of funds from the sale of assets 
of partnership as given in Sec. 40 of the U.P.A. 

5. If a partner dies, (a) Why should the books be closed? (b) 
Why may it be necessary to revalue the assets? 

6. If A is operating a business as a sole proprietor with assets in 
amount of $20,000 and liabilities of $14,000, 

(a) How much should B contribute in cash if he is to join A 
as an equal partner? 

(/;) How much should B contribute in cash if he is to have a 
one third interest. 

7. Presume the same case as in Question 6, but that A feels there 
should be $3000.00 for good-will written onto the books before B is 
admitted. How much should B invest if he is to be an equal partner, 
presuming he agrees to the good-will? 

8. If partners agree to liquidate, 

(a) What are the usual duties of the liquidating partner? 

(b) What should the liquidating partner do if the assets are 
not sufficient to pay the liabilities in full? 

9. When and how may good-will be placed on partnership books? 

10. (a) Describe a limited partnership. 
(b) How is it formed? 

11. Why should a special or limited partner be a silent partner? 



PROBLEM MATERIAL 



273 



PROBLEM MATERIAL 

PROBLEM i 

The following balance sheet was taken from the books of the Bar- 
ney and Cole Co. at December 31, 19 : 

BARNEY AND COLE Co. 
Balance Sheet as of Dec. 31, 19 



Assets 




Cash 
Accounts Rec'ble 
Notes Rec'ble 
Inventory 
Land 
Buildings 
Machinery and Equipment 


$ 3,200.00 
17,500.00 
2,000.00 
14,000.00 
6,000.00 
30,000.00 
10,000.00 


$82,700.00 



Liabilities 
Accounts Payable 
Notes Payable 
Mortgage Payable 
Total Liabilities 

Net Worth 
Barney Capital 
Cole Capital 



$20,500.00 

4,200.00 

18,000.00 

42,700.00 



25,000.00 
_i 5,000.00 
$82,700.00 



(a) Assume Douglas wishes to join the partnership as a one-third 
owner. How much cash must he pay if the cash is to go into the busi- 
ness? 

(b) How much cash must he pay, assuming that the cash is to be 
paid to Barney and Cole as an outside consideration, and they agree 
to reduce their capital accounts proportionately? 

(c) Write the journal entry or entries required to accomplish both 
(a) and (b) above. 

PROBLEM 2 

Using the same balance sheet as in Problem i : 

Assume that Barney and Cole, who have been losing money, appeal 
to Douglas to join them as a partner. 

An independent C. P. A. examines the books and records of the 
partnership to see that the assets are conservatively valued. His rec- 
ommendations are as follows: 

(1) $1500.00 of Accounts Receivable are worthless and should be 
charged off. 

(2) Five per cent of the balance of Accounts Receivable should be 
set up as a Reserve for Doubtful Accounts. 

(3) The Inventory should be revalued at $10,000.00. 

(4) A Reserve for Depreciation of Buildings should be set up cal- 
culated at 20 % of the Buildings' cost. 

(5) A Reserve for Depreciation of Machinery and Equipment should 
be set up in amount of $2000.00. All other items are in order. 



274 



FUNDAMENTALS OF ACCOUNTING 



Mr. Douglas reports his accountant's findings and indicates that 
he will join, provided the partners re-value the assets as indicated in 
the accountant's report. He will invest a sum sufficient to make him 
a one-half owner. 

Barney and Cole, who have been sharing all profits 5/8 and 3/8, 
agree. 

Required: 

(1) Journal entries to revalue assets in accordance with the ac- 
countant's report. 

(2) Journal entry to record Douglas investment. 

(3) A balance sheet of the new firm which is to be known as the 
B-C-D Company after Mr. Douglas has been admitted. 

PROBLEM 3 

Mr. Farlee and Mr. Rose have been partners for many years, shar- 
ing gains and losses equally. They both wish to retire, but because 
they cannot sell the business as a going concern they plan to liquidate 
it as rapidly as possible. A balance sheet taken from their records 
at July 15, 19 , reveals the following condition: 

FARLEE-ROSE Co. 

Balance Sheet as of July 15, 19 



Assets 




Liabilities 




Cash 


$ 4,200.00 


Notes Payable 


$ 3,000.00 


Notes Rec'ble 


3,600.00 


Accounts Payable 


26,000.00 


Accts. Rec'ble 


16,500.00 


Mortgage Payable 


25,000.00 


Store Bldg. & Site 


45,000.00 




54,000.00 


Store Equipment 
Office Equipment 


8,000.00 
2,700.00 


Net Worth 




Inventory 


38,000.00 


Farlee Capital 


40,000.00 


Delivery Equipment 


6,000.00 


Rose Capital 


30,000.00 




$124,000.00 




$124,000.00 



At September ist the assets have been wholly liquidated. The as- 
sets exclusive of cash were sold for a total of $85,800.00. The neces- 
sary expenses of liquidation amounted to $800.00 and were paid in 
full as were all the firm's liabilities. 

Required: All journal entries necessary to close the books of the part- 
nership, including the sale of the assets, the payment of the lia- 
bilities and expenses of liquidation, the distribution of any gain or 
losses and final cash settlement. 

PROBLEM 4 

B. Gross and C. Howard are partners and conduct a wholesale 
hardware business under the firm name of the Gross Howard Co. The 
partnership agreement among other clauses provides for interest, 
drawings, and profits as follows: 



PROBLEM MATERIAL 275 

1. No salary shall be allowed, but each partner may draw up to 
$300.00 per month in anticipation of profits. 

2. No capital investments or withdrawals shall be made except by 
mutual consent of the partners. 

3. Interest shall be allowed on all capital invested at the rate of 6% 
per annum. 

4. Any profit or loss remaining after providing for interest and part- 
ners' drawings is to be shared equally. 

The following capital and drawing accounts appear on the books 
at December 3ist. The company has realized an operating profit of 
$14,800.00 and all accounts have been closed except those below. 

B. GROSS CAPITAL 



Jan. i Balance $32,000.00 

C. HOWARD CAPITAL 



Jan. Balance $36,000.00 

B. GROSS DRAWINGS 



Dec. 31 total $3,600.00 



C. HOWARD DRAWINGS 



Dec. 31 total $3,600.00 



PROFIT AND Loss SUMMARY 



Dec, 31 Balance $14,800.00 

Required: Considering the articles of co-partnership above, complete 
the closing of the books. Give the journal entries and ledger ac- 
counts. 



CHAPTER XVI 
CORPORA TIONS ~ ORGANIZA TION 

Corporations are usually divided into two large groups : Pub- 
lic or Governmental Corporations, and Private Corporations. 
Our discussion is concerned only with Private Corporations, ex- 
cluding banks, insurance, and railroad corporations. 

DEFINITION AND CHARACTERISTICS OF CORPORATIONS 

In 1819 Chief Justice Marshall, in the now famous Dart- 
mouth College case, defined a corporation. This definition has 
been quoted by almost every writer on corporations, and is 
repeated here because it does enumerate the characteristics of 
the corporation. " A corporation is an artificial being, invisi- 
ble, intangible and existing only in contemplation of law. Being 
the mere creature of law, it possesses only those properties 
which the charter of its creation confers upon it, either ex- 
pressly or as incidental to its very existence. These are such 
as are supposed best calculated to effect the object for which it 
was created. Among the most important are immortality, and, 
if the expression may be allowed, individuality; properties, by 
which a perpetual succession of many persons are considered as 
the same, and may act as a single individual. They enable a 
corporation to manage its own affairs, and to hold property, 
without perplexing intricacies, the hazardous and endless neces- 
sity, of perpetual conveyances for the purpose of transmitting 
it from hand to hand. It is chiefly for the purpose of clothing 
bodies of men, in succession with these qualities and capacities, 
that corporations were invented and are in use. By these means 
a perpetual succession of individuals are capable of acting for 
the promotion of the particular object, like one immortal be- 
ing." (Dartmouth College vs. Woodward (U. S. 1819) 518.) 

A corporation has the status of a separate legal entity, hav- 
ing an existence separate and apart from its members. In the 
eyes of the law it is an " artificial being," and in the statutes 
where the word " person " is used it usually refers to corpora- 
tions as well as to " natural persons." It is created by law and 
exists only in contemplation of law. It may sue and be sued in 

276 



CORPORATIONS ORGANIZATION 277 

the corporation name. It is different from a partnership in that 
a partnership is not a legal entity, but a personal relationship 
growing out of a contract. In the corporation the State creates 
a separate legal entity. The acts of the partnership are the acts 
of the individual members. If a creditor wishes to sue a part- 
nership, he sues the individual partners comprising the partner- 
ship. On the other hand, in the case of corporation, the 
corporation through its officers may act as an entity, and, as 
was said above, creditors may sue the corporation, in the 
corporate name. 



ADVANTAGES OF THE CORPORATE FORM OF ORGANIZATION 

1. Limited Liability of Stockholders. When one purchases a 
share of stock in a newly organized corporation and pays to the 
corporation the* full face, or par, value of the share, then legally 
he cannot be held for any further contribution to the corpora- 
tion. If the corporation fails he may lose his entire investment, 
but he can lose no more (except in one or two States where 
double liability exists, as in California). This is a very attrac- 
tive feature to the small investor, who may be willing to invest 
a small sum in a corporation in anticipation of large profits, but 
who cannot take any risks in excess of his investment. 

2. Ownership Evidenced by Transferable Shares. Another 
very attractive feature of the corporate form of organization is 
the fact that when one purchases a share of stock he receives a 
certificate as evidence of such ownership, which is transferable 
by assignment. This advantage makes it possible for the in- 
vestor to sell and easily assign his stock to a new owner, who 
may have the stock registered in his name. This advantage 
leads to the third. 

j. Possibility of Large Aggregate Capital. Because of the 
fact that the ownership may be divided into transferable 
shares, the par value of which may be small, it is possible to 
sell a great deal of the stock to the small investor, who could not 
purchase a large interest in any business. The usual par value 
is one hundred dollars, although ten, twenty-five, and fifty dollar 
par values are quite popular; and also a more recent practice 
is the issuance of stock without par value. Another advantage 
which will " draw " capital is the fact that certain shares may 



278 FUNDAMENTALS OF ACCOUNTING 

be " preferred." This feature will be discussed later in the 
chapter. 

4. A More Stable and Permanent Form of Organization. In 
the single proprietary form of organization or partnership, 
death automatically dissolves the partnership and necessitates 
a reorganization before the business may continue. It may 
even mean the termination of the enterprise altogether. 

In the corporate form of organization the death of the prin- 
cipal stockholder need not mean reorganization, because of the 
fact that his holdings consist of transferable shares, which 
usually can be disposed of without a great deal of trouble. The 
death of the average stockholder has no bearing nor effect on 
the existence of the corporation. The life of a corporation may 
be said to be perpetual, because most States permit corporations 
to continue indefinitely until dissolved according to law. 

5. Legal Entity an Advantage. The fact that a corporation 
is a distinct legal entity is an advantage, because it permits the 
corporation to take title to real property in the corporation 
name; and, similarly, to sue or be sued in the corporation name, 
or to negotiate contracts in the name of the corporation. 

DISADVANTAGES OF THE CORPORATE FORM OF ORGANIZATION 

/. Corporation Taxes and Numerous Reports. The corpora- 
tion, being " a creature of the State/ 7 is subject to supervision 
and control by the State from which the charter is granted. At 
present corporations are taxed by both the State and the Federal 
governments. As a basis for taxation and for other reasons 
both the State and the Federal governments require that a great 
many reports be furnished. These reports should not be so 
difficult to prepare if the corporation keeps good accounting and 
statistical records. Many corporations feel that the prepara- 
tion and filing of long detailed reports with various govern- 
mental boards not only puts a burden on them, but some of the 
information contained in these reports, being more or less pub- 
lic property, might be secured by competitors and used to the 
detriment of the reporting corporation. 

2. Limited Liability of Stockholders. It will be noted that 
this reason was given as an advantage to the stockholders, and 
so it is ; but to the corporation it may work as a disadvantage 



CORPORATIONS ORGANIZATION 2 79 

when it contemplates borrowing funds. A corporation can 
pledge only the assets of the corporation, and very frequently 
banks will not loan unless one or two of the officers of the cor- 
poration will endorse the corporation's note. This, of course, is 
quite a disadvantage, particularly to the interested officers. 

3. Lack of Personal Interest in Management. Another point 
often mentioned by writers on corporations, as a disadvantage, 
is the fact that the managers of the corporation lack the real 
personal interest which is present in the sole proprietary and 
the partnership forms of organization. This can very readily 
be overcome by giving shares to all executives and junior execu- 
tives, thus making them stockholders in the corporation, 

4. Limitation of Activity. Another disadvantage, quite fre- 
quently cited by writers on corporations, is the fact that a cor- 
poration is limited in its activities to the powers granted in its 
charter. This may be overcome, however, by drawing the 
clause describing the scope of the corporation wide enough to 
allow for possible expansion. 

Without going any further into advantages or disadvantages 
of the corporate form of organization, let us now see the pro- 
cedure necessary to the formation of a corporation. 

FORMATION OF A CORPORATION 
PROCEDURE IN GETTING A CHARTER 

Corporations are spoken of as " creatures of the law" be- 
cause they come into being by means of a " charter " or grant 
from one of the States of the Union. Each State has its own 
corporation law. This law is not uniform in all States, nor has 
any uniform law, such as the Uniform Partnership Act, been 
applied to the law of corporations. 

At one time the legislatures granted all charters, but today, in 
the majority of States, this power has been delegated to the 
Secretary of State or to an officer of similar authority. In most 
States at least three incorporators are necessary. These in- 
dividuals must take upon themselves the liability of forming the 
corporation. A considerable amount of business may have to 
be transacted before the charter is granted and the corporation 
started. In the meantime, the incorporators are jointly and 
severally liable for any debts they contract in the undertaking. 



280 FUNDAMENTALS OF ACCOUNTING 

The legal procedure is not easy, and competent legal advice 
should be summoned by those interested in launching this type 
of business enterprise. 

The usual procedure is the filing of an application for a char- 
ter with the Secretary of State of the state in which incorpora- 
tion is desired. In New York a certificate of incorporation 
must be filed with the Secretary of State at Albany, New York, 
and a copy of it must be filed with the county clerk, in the county 
in which the corporation will do business. 

APPLICATION FOR CHARTER 

The legal right to operate a corporation is obtained from the 
State government which issues a charter. As there are so many 
states, so also are there so many different state corporation acts 
which prescribe the proper method of obtaining a charter in 
their particular state. Each state provides an application form 
which should be obtained from the state in which the corpora- 
tion intends to operate. The application form, of course, varies 
just as the state laws are different, but in general the following 
points are included in all applications for charter: 

1. The name. 

2. The purpose of the corporation. 

3. The amount of stock, common (with par value and amount with- 
out value), and preferred, including the dividends to be paid on the 
latter. 

4. The city and the county in which the principal office is to be 
located. 

5. The intended duration of the corporation. 

6. The names and addresses of the directors (who must be at least 
three in number), and the names and addresses of the subscribers to 
the certificate and the number of shares the latter take. 

7. A statement that: 

(a) At least two-thirds of the subscribers to the certificate 

are adult United States citizens and, 
(/?) That at least one is a New York resident, and that, 
(c) At least one director is both a United States citizen and 
a New York resident. (From the New York State Cor- 
poration Law). 

This certificate must be signed and separately acknowledged 
by each incorporator, and forwarded to the Secretary of State 
or other officer in charge of issuing charters. 



CORPORATIONS ORGANIZATION 2 8 1 

It might be well to discuss some of the points required in the 
preceding form. 

A corporation may select and use any name which is not al- 
ready in use by another organization. 

The purpose of the proposed corporation is important, be- 
cause, when the charter is granted, this paragraph will set the 
limits of the corporation's actions. It is very wise, therefore, 
to ask for wider powers in the charter than immediate use may 
require; otherwise it may be necessary to have the charter 
amended if the corporation, subsequently, wishes to expand the 
scope of its operations. 

The next point calls for a decision on the amount of capital 
stock to issue. This is a question more of corporation finance 
than of accounting and will not be gone into at this time. The 
balance of the information on the form is routine and unimpor- 
tant from an 'accounting point of view. 

After the corporation has received its charter, it should call 
a meeting of the stockholders to elect a Board of Directors, 
adopt a set of by-laws, and transact other business of organiza- 
tion. When this preliminary work of organization is completed, 
the corporation should be ready to commence business. 

CAPITAL STOCK AND TYPES IN COMMON USE 

The amount of capital stock which a corporation may issue is 
fixed by the charter. The capital which it may raise by the sale 
of its stock is therefore limited. The amount, however, may 
subsequently be increased or decreased by amending the charter 
in accordance with the law of the State in which the charter is 
granted. 

The charter will also designate the type of stock and amounts 
of each different kind of stock which may be issued. The kinds 
of stock in common use today may be classed as: 

1 i ) Common stock, 

(2) Preferred stock, 

(a) Participating or non-participating, 

( b ) Cumulative or non-cumulative. 

COMMON STOCK DEFINED 

Common stock may be defined as that stock which has no 
preference in the matter of profits or assets over any other stock 



282 FUNDAMENTALS OF ACCOUNTING 

issued by the company. Where only one kind of stock is issued, 
common stock is used and all stockholders are on a common 
footing. The common shareholders usually elect a Board of 
Directors and through this group maintain control of the 
company. 

PREFERRED CAPITAL STOCK 

Capital stock which carries with it some preference over the 
common stock is known as preferred capital stock. The usual 
preferences are as to division of profits and division of assets in 
case of dissolution. 

The preference in the division of profits usually takes the 
form of a fixed rate on the face or par value of the shares, or so 
many dollars or cents per share in case of shares without par 
value, which must be paid from earnings of the corporation be- 
fore any dividends may be distributed to the holders of the 
common stock. 

To illustrate, suppose the Cambria Manufacturing Company 
has issued 1000 shares of common stock with a par value of 
$100. per share, and 1000 shares of 8% preferred stock whose 
par value is also $100. Suppose, at the end of the year, the com- 
pany reports a profit of $17,500. 

The holders of the preferred shares will first receive 8% of 
the par value of their holdings. This will require $8000. The 
Board of Directors will then vote as to what disposition they 
will make of the other $9500. It is not a good policy to pay 
out all earnings in the form of dividends, so that the Board of 
Directors may pay 6% to the holders of the common stock and 
set the remainder aside in the surplus account. 

The preferred stock may be issued as either cumulative or 
non-cumulative, as regards the eight per cent dividends. If it 
is cumulative and the earnings of any one year are not sufficient 
to pay the eight per cent, then any deficiency accumulates to the 
credit of the preferred stockholders, and will be paid to them 
before any dividends may be given to the holders of the com- 
mon stock. 

For illustration, suppose the Cambria Manufacturing Com- 
pany in 1938 paid the preferred stockholders only 5%, and paid 
nothing in 1939, and in the year ended December 31, 1940, 
made $17,500, as in the previous case. 



CORPORATIONS ORGANIZATION 2 83 

Under these circumstances the holders of the 8% preferred 
stock would have due them 3% from 1938, 8% from 1939, and 
8% for 1940, or 19% in all. This would require a payment of 
$19,000. to liquidate. The usual procedure is to pay the high- 
est even per cent or even half per cent and allow the balance 
to accumulate. The Board of Directors, therefore, might pay 
to the holders of preferred stock $17,000, which would be 17%, 
leaving 2% to be paid from subsequent earnings. 

The preferred stock, if non-cumulative under the same set 
of facts as just given, would have received $% in 1938, nothing 
in 1939, and only 8% in 1940. 

A very interesting fact in favor of preferred stockholders is 
that preferred shares are held to be cumulative unless other- 
wise stated. 

Preferred stock may also be made participating or non- 
participating. ' When a participating clause is granted in favor 
of the preferred stockholders, they participate in an agreed 
manner with the holders of the common stock after each class 
of stock has received a stipulated rate. For instance, suppose 
the A. B. Drake Company, Inc., has issued 1000 shares of 5% 
preferred stock, par $100. which is participating equally with 
the holders of common stock (1000 shares par $100.) in all 
earnings remaining after the preferred stockholders shall have 
received five per cent and the common stockholders six per cent. 

Let us suppose that the earnings for 19 are $15,500. 

The holders of the preferred stock and the common stock- 
holders will received $5000 and $6000 respectively. This will 
leave $4500 to be divided equally between the holders of the 
preferred and the common. The largest even per cent which 
can be given is an additional two per cent to each. This will 
leave $500 for surplus. The Board of Directors may desire to 
allow a larger sum to remain in surplus and can vote to with- 
hold any part of the earnings above the dividends which must 
be paid to the preferred stockholders. 

In the last case, if the preferred stock was non-participating, 
the holders would have received only five per cent and the com- 
mon stock might have been voted a much larger dividend. 

Without going any further into a study of the various kinds 
of stock which a corporation may issue, we shall now study the 
entries required when a corporation is started. 



284 FUNDAMENTALS OF ACCOUNTING 

OPENING ENTRIES FOR A CORPORATION 

A corporation may sell and issue its capital stock just as soon 
as it receives its charter. In studying the following entries, 
the student is cautioned to note carefully the accounts used. 
The names of accounts dealing with the subscription, sale, and 
issue of capital stock, must be selected very carefully so that the 
titles used will accurately describe what the accounts are sup- 
posed to represent. 

In presenting the opening entries we shall again use the case 
method and illustrate the more common situations which are 
met when the corporation is first organized. 

Case No. i 

Suppose the Thornton Shoe Company, Inc., is organized to 
manufacture and sell shoes, and that its charter permits it to 
issue $500,000. worth of common capital stock with a par value 
of $100. per share. 

A, B, and C, the incorporators, have subscribed for and paid 
in cash the following number of shares: A 200 shares, 
$20,000.; B 100 shares, $10,000.; and C 80 shares, 
$8000. The remainder of the stock is to be offered to the public 
later. 

The following entries will now be made and discussed: 

GENERAL JOURNAL 

i 

Unissued Capital Stock $500,000.00 

Capital Stock $500,000.00 

To record the authorized capital 
stock of the Thornton Shoe Com- 
pany, Inc., 5000 shares par value 
$100. 

This entry sets the authorized issue of capital stock on the 
books. At this moment of time, no stock has been issued; 
therefore, the Unissued Capital Stock account offsets the Capi- 
tal Stock account. We shall now see how the sale of part of the 
capital stock to the original incorporators affects these accounts. 



CORPORATIONS ORGANIZATION 



285 



Cash $ 38,000.00 

Unissued Capital Stock $ 38,000.00 

To record the receipt of cash from 

the three original incorporators and 

the issuance of the certificates as 

follows: 

A 200 shares at par $20,000.00 

B 100 shares at par 10,000.00 

C 80 shares at par 8,000.00 
Total 380 shares $38,000.00 

This entry cuts down the Unissued Capital Stock account by 
$38,000.00. The Unissued Capital Stock account, although 
resembling an asset in several ways, is not to be treated as an 
asset, but rather as a deduction from the Capital Stock account 
on the liability side of the balance sheet. This would be shown 
on the balance sheet of the Thornton Shoe Company, Inc., as 
follows : 

THE THORNTON SHOE COMPANY, INC. 
Balance Sheet as of March i, 19 



Assets 
Cash $38,000.00 


Liabilities 

Net Worth 
Capital Stock: 
Authorized 
Less Unissued Capital 
Stock 
Issued and Outstanding 


None 

$500,000.00 
462,000.00 


38,000.00 


$38,000.00 


$ 38,000.00 



Case No. 2 

Let us suppose that the Thornton Shoe Company, Inc., after 
offering its stock for sale to the public, has received at April i 
subscriptions to 2000 shares of the stock on the following terms: 
10% cash with subscription contract and the balance to be 
paid in three equal installments, payable one month, two 
months, and three months, respectively. The stock is to be 
issued only after the last payment is made. The following jour- 
nal entries will be made to handle this situation completely: 



286 FUNDAMENTALS OF ACCOUNTING 

GENERAL JOURNAL 

-i- 
Subscription Contracts Receivable $200,000.00 

Subscribed Capital Stock $200,000.00 

To record the receipt of Capital 
Stock Subscriptions from sundry 
subscribers. 

-2- 
Cash 20,000.00 

Subscription Contracts Rec'ble . 20,000.00 

To record the Cash received with 
the subscription contracts 10% of 
the amount subscribed. The bal- 
ance is to be paid, $60,000.00 May 
i ; $60,000.00 June i ; and $60,- 
ooo.oo July i. 

As these installments become due, a call will be sent to the 
subscribers for payment, and when the cash is received the stock 
will be issued. The following journal entries will illustrate the 
complete situation: 

May i 

Cash $ 60,000.00 

Subscription Contracts Rec'ble . $ 60,000.00 

To record the receipt of installment 
No. i due today entire amount re- 
ceived. 

June i 

Cash 60,000.00 

Subscription Contracts Rec'ble . 60,000.00 

To record the receipt of installment 
No. 2 due today entire amount re- 
ceived. 

July i 

Cash 60,000.00 

Subscription Contracts Rec'ble . 60,000.00 

To record the final payment on sub- 
scriptions due today all payments 
received. 

July i 

Subscribed Capital Stock 200,000.00 

Unissued Capital Stock 200,000.00 

To record the issuance of 2000 
shares of Capital Stock fully paid 
as per subscription contracts. 



CORPORATIONS ORGANIZATION 



287 



Next will be presented two balance sheets of the Thornton 
Shoe Company, Inc. The first is as of June i, and will show 
the status of the several accounts required at that date. The 
second balance sheet will show the financial condition of the 
Thornton Shoe Company, Inc., as of July i, after the stock has 
been issued: 



THE THORNTON SHOE COMPANY, INC. 
Balance Sheet as of June i 



Assets 
Cash 

Subscription Contracts 
Receivable 



$178,000.00 
60,000.00 



$238,000.00 



Liabilities 
Subscribed Capital Stock $200,000.00 



Net Worth 

Capital Stock 

Authorized $500,000.00 
Less Unissued 

Cap. Stock 462,000.00 
Issued and 

Outstanding 



38,000.00 
$238,000.00 



In the balance sheet of June i, above, it will be noted that 
the Subscription Contracts Receivable account has a balance 
of $60,000.00. This is exactly the amount due to the corpora- 
tion from the subscribers. At the same time the company has 
a liability to the subscribers for the Subscribed Capital Stock. 
This is $200,000.00, the full amount of subscriptions. This 
liability is not reduced when the installments are received, as 
is the asset Subscription Contracts Receivable, but is written 
off the books only after the actual shares are issued to the sub- 
scribers when their contracts are fully paid. 

In the following balance sheet it will be noted that both the 
asset account Subscription Contracts Receivable and the lia- 
bility account Subscribed Capital Stock have disappeared from 
the balance sheet. It will also be noted that at this date the 
amount of Capital Stock, issued and outstanding, is now 
$238,000.00. This amount is made up of the original issue of 
$38,000.00 to A, B, and C, and $200,000.00 to sundry sub- 
scribers, whose subscription contracts have just been fully paid 
by the receipt of the final installment of $60,000.00. 

The next balance sheet illustrates the financial condition of 



288 FUNDAMENTALS OF ACCOUNTING 

the Thornton Shoe Company, Inc., after the last payment is 
received and the stock issued : 



THE THORNTON SHOE COMPANY, INC. 
Balance Sheet as of July i 



Assets 
Cash $238,000.00 



$238,000.00 



Liabilities 
Liabilities None 

Net Worth 

Capital Stock Authorized 
$500,000.00 
Less Unissued 

Cap. Stock $262,000.00 
Issued and Outstanding 238,000.00 

$238,000.00 



SECOND METHOD OF HANDLING SUBSCRIPTIONS TO 
CAPITAL STOCK 

In the method above it will be noted that the capital stock 
subscribed to was paid in a series of installments, and was 
not issued to the subscribers until after the last payment was 
made by the subscriber, or until his contract was fully paid. 
This procedure is quite widely followed in practice, because it 
is much more convenient to the management to have on hand 
unissued stock of a subscriber who has failed to meet his pay- 
ments, and which under the law may be forfeited to the cor- 
poration to be sold as described later, rather than have issued 
the stock and then to have to get it back again from the de- 
faulting subscriber. 

Some accountants, however, motivated by a legal fact that, 
once a subscription contract has been signed by the subscriber 
and accepted by the corporation, contend that the subscriber 
is the legal owner of the stock and should therefore get posses- 
sion of the certificate ; the subscription contract being his writ- 
ten promise to pay according to its terms. These accountants 
advocate the following entry when the subscription contract is 
signed by the subscriber and accepted by the corporation : 

-i- 
Subscription Contracts Receivable $200,000.00 

Unissued Capital Stock $200,000.00 

To record receipt of subscriptions 



CORPORATIONS ORGANIZATION 289 

to 2000 shares of common Capital 
Stock of the Thornton Shoe Com- 
pany, and the issuance of the shares 
to the subscriber. 

Then the same three entries showing the payment of the sub- 
scription installments May i, June i, and July i would be 
recorded as in the first method. 



METHOD SHOWING CALLS 

It was stated in the first method that calls or notices of in- 
stallments due are sent to the subscribers. These calls are 
mailed out usually from ten days to two weeks before the pay- 
ment is due. Some accountants at this time write a general 
journal entry converting each installment into a separate 
" call " account as follows: 

May 15 

Call No. i (due June i) $60,000.00 

Subscription Contracts Receivable . . . $60,000.00 

To record issuance of Call No. i for pay- 
ment of installment due June i. 

Then, as cash is received from the subscribers, it is credited 
to the Call account rather than directly to the Subscription 
Contracts account. The advantage claimed for this procedure 
is that defaulting subscriptions are more easily recorded. If 
Call accounts are used, the other entries will be made as before, 
and Call accounts may be used in either method previously 
described. 

FORFEITED STOCK 

When stock is sold on installments, it often happens that one 
or more subscribers will fail to complete their payments to the 
corporation. The corporation laws of most States, under such 
circumstances, grant the corporation the right to forfeit the 
stock. That right, however, is entirely statutory, and the pro- 
visions of the Statute must be observed. While most States 
permit corporations to forfeit shares not fully paid as per the 
subscription contract, they usually provide that the corpora- 
tion sell the stock at public auction and credit the proceeds to 
the unpaid subscription contract. Any balance left after the 
debt is paid must be returned to the defaulting subscriber, less 



2QO 



FUNDAMENTALS OF ACCOUNTING 



any expenses of the sale. In each case before forfeiting stock 
for unpaid subscriptions, the Statutes of the State in which the 
corporation is chartered should be consulted for the proper 
procedure. 

In the State of New Jersey, from the General Corporation 
Act Section 23 (1936), we find this regarding " Non Payment 
of Assessments; Sale of Shares ": 

" If the owner of any shares shall neglect to pay any sum 
assessed thereon for thirty days after the time appointed for 
payment, the treasurer, when ordered by the Board of Direc- 
tors, shall sell at public auction, such number of shares of the 
delinquent owner as will pay all assessments then due from him, 
with interest, and all incidental charges, and shall transfer the 
shares sold to the purchaser, who shall be entitled to a certifi- 
cate therefor." 



ACCOUNTING FOR FORFEITED SUBSCRIPTIONS 

The accounting entries for forfeited stock must obviously 
depend upon the manner in which the subscription entries were 
handled. 

Suppose that Mr. Henry Jones, who subscribed for ten shares 
of stock, has failed to pay the June and July installments. Let 
us suppose for simplicity's sake that he is the only subscriber 
who has failed to pay his contract in full. Then his account 
and the Subscriptions Contracts Receivable account would each 
show a debit balance of $600.00 as follows : 

SUBSCRIPTIONS CONTRACTS RECEIVABLE 



April i 


Total 


subscrip- 




April i 


Down Payment 


$20,000.00 




tions 




$200,000.00 


May i 


Installment i 


60,000.00 










June i 


Installment 2 


59,700.00 










July i 


Installment 3 


59,700.00 



HENRY JONES 


April i Ten shares $1,000.00 


April i 
May i 


Down payment 
Installment i 


$100.00 
300.00 



Thirty days have elapsed since the last call was due, and the 
Board of Directors, by proper resolution, have declared the ten 
shares of stock subscribed to by Mr. Henry Jones forfeited and 



CORPORATIONS ORGANIZATION 



291 



have ordered the treasurer of the company to proceed with the 
sale of the stock in accordance with the law. 

-August i 

Forfeited Stock $1000.00 

Forfeited Stock Surplus $1000.00 

To record forfeiture and cancellation of 
Certificate No for ten shares sub- 
scribed to by Mr. Henry Jones and de- 
clared forfeited this day by resolution of 
the Board of Directors. 

-September i- 

Cash 800.00 

Forfeited Stock Surplus 200.00 

Forfeited Stock 1000.00 

To record sale of ten shares of capital 
stock to Mr: J. MacGregor. Shares for- 
feited August first. Proceeds of sale 
$800.00. 

Subscribed Capital Stock 1000.00 

Unissued Capital Stock 1000.00 

To record issuance of certificate No 

to Mr. J. MacGregor, in place of certifi- 
cate No declared forfeited and can- 
celled. 

Forfeited Stock Surplus 40.00 

Cash 40.00 

To charge the forfeited stock surplus with 
cost of advertising and auctioneer's fees. 

Forfeited Stock Surplus 600.00 

Subscriptions Contracts Receivable 

(Jones) 600.00 

To apply part of proceeds of auction to 
cancel the subscription contract of Mr. 
Jones now fully paid. 

Forfeited Stock Surplus $ 160.00 

Cash : $ 160.00 

To record the payment of the net surplus 
due Mr. Jones. 



292 FUNDAMENTALS OF ACCOUNTING 

After these journal entries have been posted, the Subscrip- 
tion Contracts Receivable account and the Subscription ac- 
count of Henry Jones will be closed, paid in full. All the stock 
fully paid will have been issued. The expenses of the sale were 
paid from the proceeds, leaving $160.00 which was mailed to 
the defaulting subscriber together with a statement of his ac- 
count. This completes the case for forfeiture. 



NO PAR VALUE STOCK 

Before 1912, when New York State enacted a law allowing 
the issuance of capital stock without par value, corporations 
had to fix some par or face value for their shares. The most 
usual amount was $100.00. The amount would be very prettily 
engraved across the face of the certificate and to the uninitiated 
it would indicate that the value of the stock must be one hun- 
dred dollars or very close to it. The book value of the shares 
might be closer to ten dollars than to the one hundred dollar par 
value, but psychologically the engraved par value attached to 
the shares a meaning which had no bearing on the true value of 
the stock. 

The practice before 1912 of insisting on corporations fixing a 
par value for its shares and placing a liability upon the board 
of directors if they issued any stock for less than par value led 
to many subterfuges in an effort to make the issue legally " full 
paid." One of the common practices was to issue blocks of 
stock as fully paid for property which was given highly inflated 
values, or to give a fabulous value to " good-will/' " patent 
rights, 77 or other intangible assets. 

A corporation which issues stock of no par value need not 
resort to any subterfuge in order to prove legal full payment. 
Stock issued at no par value may be sold at any price acceptable 
to the corporation, usually decided upon by the Board of 
Directors. When shares are issued with no par value, the in- 
vestor is at least put on his guard to ascertain the real value of 
the shares and the company issuing them. 

Since 1912 many States have passed acts similar to the one in 
New York, permitting the issuance of shares without par value. 
The law regarding no par value stock varies in the several 



CORPORATIONS ORGANIZATION 2 93 

States. While the stock is said to be without par value, many 
States have insisted on a minimum nominal value. This mini- 
mum in several States is five dollars per share. 

The recording of stock without par value offers several prob- 
lems to the accountant. In the cases of no par value stock, the 
Authorized Capital Stock and the Unissued Capital Stock ac- 
counts cannot be placed on the books, since its value cannot be 
determined until it is sold. When the shares are sold, how- 
ever, the amount received should be placed to the credit of 
Capital Stock account. To illustrate this let us assume the fol- 
lowing case : 



CASE I STOCK ISSUED WITHOUT PAR VALUE 

Suppose the Thompson Construction Company is authorized 
to issue 5000 shares of stock without par value and the first sale 
is 1000 shares at $62.00 a share. 

The journal entry would be as follows: 



GENERAL JOURNAL 

Cash $62,000.00 

Capital Stock $62,000.00 

To record the sale and issue of 1000 
shares of no par value stock at $62.00 
a share. 



NO PAR STOCK ON THE BALANCE SHEET 

On the balance sheet of the Thompson Construction Com- 
pany the Authorized and Unissued Capital Stock accounts 
would be as follows: 



Assets 
Cash $62,000.00 



62,000.00 



Liabilities 

Net Worth None 

Capital Stock 
No par value 
Authorized 5 ,000 shares 
Less Unissued 4,000 shares 

Outstanding 1,000 shares 

62,000.00 

$62,000.00 



294 FUNDAMENTALS OF ACCOUNTING 



NO PAR SUBSCRIPTIONS 

When no par value stock is sold through subscriptions the 
same procedure is followed as with par value stock except that 
the subscription contracts are entered on the books at the sale 
price of the stock. 

TREASURY STOCK 

Treasury stock is the company's own stock which has been 
once issued, and fully paid, and which has been reacquired by 
the corporation by some means other than forfeiture, usually 
through purchase or donation. 

Treasury stock must not be confused with unissued capital 
stock. Unissued stock is stock of the corporation that has never 
been issued to anyone, while treasury stock is stock that has 
been once issued and fully paid before it is reacquired. Un- 
issued stock cannot be sold and issued as full-paid by the cor- 
poration unless the corporation receives the full par value in 
either cash, property, or services. The corporation, on the 
other hand, may dispose of treasury stock at any price it chooses 
because these shares were once issued as fully paid. 

Treasury stock may come into existence in several ways. A 
very common method of acquiring treasury stock is for a cor- 
poration to have issued a block of its stock in payment for some 
potentially valuable asset, such as a new patent, and then have 
the inventor who is interested in the success of the corporation 
donate back certain shares to be sold by the corporation for 
working capital. This stock, having been once fully paid, may 
be sold below par, and the directors of the corporation will be 
entirely free from liability. 

Let us see the accounting required when treasury stock is 
acquired under these conditions : 

Case i Treasury Stock by Donation. Suppose the Lamb 
Safety Razor Company, Inc., is organized to manufacture and 
sell a newly patented safety razor, and that Mr. F. Lamb, the 
inventor, assigns his patent to the corporation for $100,000.00. 
He receives 1000 shares of the company's common stock as full 
payment for the patent and subsequently donates back to the 
company 500 shares for the purpose of advertising his safety 
razor. 



CORPORATIONS ORGANIZATION 295 

The following entries will be written to give effect to the facts 
above: 

GENERAL JOURNAL 

_ T 

Patent Rights $100,000.00 

Unissued Capital Stock $100,000.00 

To record the purchase of the pat- 
ent rights from Mr. F. Lamb for 
$100,000.00 paid for by issuance of 
1000 shares of Capital Stock. 

-2- 

Treasury Stock $ 50,000.00 

Surplus for Advertising $ 50,000.00 

To record receipt of 500 shares 
from Mr. Lamb to be sold to pro- 
vide funds for advertising. 

Let us assume, at this point, that the company is able to dispose 
of the entire 500 shares of stock for $30,000.00. 

Cash $ 30,000.00 

Surplus for Advertising 20,000.00 

Treasury Stock $ 50,000.00 

To record sale of Treasury Stock to 
X for $30,000.00. 

In this illustration, when the 500 shares were donated back 
to the corporation, the stock was treated as Treasury Stock and 
its par value credited to the Surplus for Advertising. This is 
done so that the money received from the sale of the stock will 
be used as requested by the donor. If the value of these shares 
were entered to the credit of the general surplus account, then 
these funds would be available for distribution as dividends and 
thus possibly defeat the purpose of the donor. 

It is, therefore, good accounting practice for the corporation 
to credit the value of the donated shares to some " ear-marked " 
Capital Surplus account, such as the one used in the foregoing 
illustration. When the stock is subsequently sold, the true 
value of this surplus is determined, and adjusted in the entry 
recording the sale of the stock. In the case above, the stock 
which had a $50,000.00 par value brought $30,000.00, and 
therefore the Surplus for Advertising account was written down 
to its true value. 



296 FUNDAMENTALS OF ACCOUNTING 

Case 2 Treasury Stock by Purchase. Treasury stock may 
result from the corporation purchasing back part of its own 
stock in the open market. This is commonly done and is very 
often good business, because quite frequently the book value of 
a stock may be considerably higher than the market price. The 
Board of Directors may authorize the treasurer or other officer 
to buy shares when such conditions prevail. This stock may 
then be held in the treasury until the market price rallies and, 
perhaps, a handsome profit may be realized. 

To illustrate this procedure and the accounting required let 
us assume the following facts : 

The Lamb Safety Razor Company, Inc., now a successful 
manufacturing organization, has cash available, and a good sur- 
plus. The book value of its shares is $106.00, while the stock 
is quoted at $84.00 a share. The Board of Directors, there- 
fore, vote to buy 1000 shares of its stock at $84.00, which pur- 
chase is immediately executed. 

The following journal entry will record the purchase: 

GENERAL JOURNAL 

Treasury Stock $100,000.00 

Cash $ 84,000.00 

Treasury Stock Surplus 16,000.00 

To record the purchase of 1000 

shares of the Lamb Safety Razor 

stock as per resolution of the Board 

of Directors at $84.00 per share. 

This entry will show the receipt of the shares and the reduc- 
tion in cash. The stock is recorded at par and the difference 
is credited to the Treasury Stock Surplus account. 

Let us assume further that three months later the market 
price is $96.00, the Board of Directors order the 1000 shares 
sold, and the order is promptly executed. 

At this time the following entry should be written: 

GENERAL JOURNAL 

Cash $ 96,000.00 

Treasury Stock Surplus 4,000.00 

Treasury Stock $100,000.00 

To record sale of 1000 shares of 
treasury stock at $96.00 a share as 
per order of Board of Directors. 



CORPORATIONS ORGANIZATION 



297 



After this entry has been posted, the credit balance of 
$12,000. in the Treasury Stock Surplus account should be trans- 
ferred to the General Surplus account. 

Treasury Stock Surplus $ 12,000.00 

Surplus $ 12,000.00 

To transfer profit on sale of treas- 
ury stock to general surplus ac- 
count. 

This entry is entirely proper because the profits from this 
operation belong to all stockholders alike; and, as a matter of 
fact, the entire transaction was made possible only through the 
fact that a general " surplus " existed. 

INCORPORATING A PARTNERSHIP 

Let us suppose that X, Y, and Z, who have been successfully 
conducting the X-Y-Z partnership for a period of years, decide 
to incorporate. They organize the Excelsior Company, Inc., 
under the laws of the State of New Jersey, with an authorized 
Capital stock issue of $200,000.00 all common shares with a 
par value of $100.00. 

X, Y, and Z, the incorporators of the Excelsior Company, 
Inc., each subscribe for ten shares and pay cash in full for their 
subscriptions. The stock is issued to the subscribers, who form 
the first Board of Directors, after the legal formalities have 
been completed. They decide to take over the partnership 
business of X, Y, and Z, paying the partners with shares of 
capital stock at par for their interest as indicated on the follow- 
ing balance sheet: 

X-Y-Z PARTNERSHIP 
Balance Sheet as of Nov. i, 19 



Assets 
Cash 
Accounts Receivable 
Inventory 
Plant and Fixed Assets 
Sundry Assets 


$10,000.00 
40,000.00 

20,000.00 
60,000.00 
20,000.00 


Liabilities 

Accounts Payable 
Mortgage Payable 
Sundry Liabilities 
Total Liabilities 
Net Worth 
X Capital $45,000.00 
Y Capital 25,000.00 
Z Capital 20,000.00 


$28,000.00 
30,000.00 
2,000.00 


$60,000.00 
$ 90,000.00 


Total Net Worth 


$I5O,OOO.OO 


$150,000.00 



298 



FUNDAMENTALS OF ACCOUNTING 



The partners accept the offer and the following entries are 
written first on the books of the corporation to record these 
facts: 



-i- 



Unissued Capital Stock $200,000.00 

Capital Stock 

To record the authorized issue of 
Capital Stock 2000 shares at par 

$100.00. 



$200,000.00 



-2- 

Cash 3,000.00 

Unissued Capital Stock 3,000.00 

To record payment of stock sub- 
scription from Mr. X, Mr. Y, and 
and Mr. Z. Each takes 10 shares 
and gives his check in full pay- 
ment and their certificates are 
issued. 

-3- 

Cash 10,000.00 

Accounts Receivable 40,000.00 

Inventory 20,000.00 

Plant and Fixed Assets 60,000.00 

Sundry Assets 20,000.00 

Accounts Payable 28,000.00 

Mortgage Payable 30,000.00 

Sundry Liabilities 2,000.00 

Unissued Capital Stock 90,000.00 

To record the assets and liabilities 
of the X-Y-Z partnership taken 
over as per resolution of the Board 
of Directors, and the issuance of 
900 shares of Capital Stock to the 
partners in payment of their respec- 
tive interests. 

At this point it might be interesting to observe the balance 
sheet of the corporation. It is illustrated on the opposite page. 

The student will note the similarity of the balance sheet of 
the partnership and that of the newly formed corporation. The 
only difference is that the net worth section of the incorporated 
company is represented by Capital Stock instead of through 
Partners' Capital accounts. In the new company the assets are 
exactly the same as before except, of course, that the $3000.00 



CORPORATIONS ORGANIZATION 



299 



the incorporators (former partners) paid into the business has 
been added to the total assets. The net worth section, how- 
ever, reflects a similar increase. This case was purposely sim- 
plified, but in general illustrates the principles involved when a 
corporation takes over a going concern. 

EXCELSIOR CORPORATION 
Balance Sheet as of Nov. 2, 19 



Assets 
Cash 
Accounts Receivable 
Inventory 
Plant and Fixed Assets 
Sundry Assets 


$13,000.00 
40,000.00 
20,000.00 
60,000.00 
20,000.00 


Liabilities 
Accts. Payable $28,000.00 
Mort. Payable 30,000.00 
Sundry Liab. 2,000.00 


$ 60,000.00 
93,000.00 


Total Liabilities 

Net Worth 
Authorized 
Capital Stock $200,000.00 
Less Unissued 
shares 107,000.00 


Issued and Outstanding 


$153,000.00 


$153,000.00 



QUESTIONS ON THE CHAPTER 

1. (a) Define a corporation. 

(b) What are its attributes? 

(c) Give in summary form the advantages and disadvantages 
of the corporate form of organization. 

2. Distinguish between: 

(a) Common capital stock and preferred stock. 

(b) Cumulative and non-cumulative preferred stock. 

(c) Participating and non-participating preferred stock. 

3. Differentiate between forfeited stock and treasury stock. 

4. If preferred stock does not mention whether it is cumulative or 
non-cumulative, how is the stock considered? 

5. List some of the important questions to be answered in filling 
out an application for a charter. 

6. (a) What is the minimum number of persons required to 
form a corporation? 

(b) What is a one-man corporation? 

7. What is no-par value stock? Describe fully. 

8. Outline the entries required to record: 

(a) Authorized capital stock $500,000 common par value 
$100.00 per share. 



300 FUNDAMENTALS OF ACCOUNTING 

(b) Jones, Farrell, and Boyce each subscribe for 100 shares, 

each paying his subscription in cash in full. 
9. (a) What accounts are usually required to record subscrip- 
tions payable in installments? 

(b) Give the functions of each account. 

10. Explain the procedure necessary to forfeit subscriptions after 
the subscriber has defaulted in his subscription. 

11. Explain two methods of acquiring treasury stock by a corpora- 
tion. 

12. Explain the difference between the Net Worth section of a bal- 
ance sheet for a partnership and the Net Worth section of a corpora- 
tion balance sheet. 



PROBLEM MATERIAL 

PROBLEM i 

W. Baker, J. Clark, and T. Dugan, who have been partners, now 
wish to incorporate as the B. C. D. Co., Inc., and through their attor- 
ney file an application for a charter under the laws of the State of 
New Jersey. Mr. Baker agrees to take 10 shares of stock, Mr. Clark 
8 shares, and Mr. Dugan 5 shares. The application for charter re- 
quests the right to issue 2000 shares of common capital stock with a 
par value of $100.00 each. 

November i : The charter has been approved and the original sub- 
scribers give certified checks for the stock subscriptions. 

Required: 

1 i ) The journal entries to open the books, showing one entry for 
the authorized issue and one for the original subscribers' pay- 
ment of their subscriptions, together with the issuance of the 
stock. 

(2) Draw a balance sheet for the corporation, after giving effect 
to the journal entries above. 

PROBLEM 2 

Asume the Board of Directors of the B. C. D. Co., Inc., in Prob- 
lem i have passed a resolution approving the purchase of the business 
formerly conducted by Messrs. Baker, Clark, and Dugan as a part- 
nership. The basis for the purchase agreement is the Balance Sheet 
listed below. The partners agree to accept common capital stock of 
the corporation at par for their net interests in the partnership. 



CORPORATIONS ORGANIZATION 



301 



BAKER-CLARK-DUGAN PARTNERSHIP 
Balance Sheet as of November i, 19 



Assets 
Cash 
Accounts Receivable 
Notes Receivable 
Land 
Buildings 
Inventory 
Office Equipment 
Sundry Assets 


$ 6,417.00 
15,523.00 
4,000.00 
3,000.00 
40,000.00 
13,060.00 

1,200.00 
300.00 


Liabilities 
Accounts Payable 
Notes Payable 
Mortgage Payable 
Total Liabilities 

Net Worth 
Baker Capital 
Clark Capital 
Dugan Capital 


$12,500.00 
3,000.00 

20,000.00 


35,500.00 

$20,000.00 

16,000.00 

12,000.00 


$83,500.00 


$83,500^00 



Required: Journal entries to record the purchase of the partnership 
business by the corporation. Give all journal entries required with 
adequate.,explanations for each entry. 

PROBLEM 3 

Assume the B. C. D. Co., Inc., wish to sell their stock to the public 
and have engaged Mr. Frank Brock to solicit a selected list of friends 
of the Directors. The terms of the subscription contracts are 10% 
cash with the signed contract and the balance payable in three equal 
monthly installments. At January 15 Mr. Brock has completed his 
canvass and turns in signed contracts from sundry subscribers total- 
ing 600 shares, together with checks in total of $6000.00. The Board 
of Directors accepts the subscriptions and pays Mr. Brock $600.00 
which is to be charged to Organization Expense. The balance of the 
subscriptions are payable February 15, March 15, and April 15, after 
which the stock is to be delivered to all fully paid subscribers. 

Required: 

(1) The journal entry for the payment of Mr. Brock. 

(2) The journal entries for the subscription and issuance of the 
stock, assuming all installments are received in full on or be- 
fore the due dates. 

PROBLEM 4 

January j. 

Frank Smith, Henry Thomas, and John Jones, all residents of the 
State of New York and citizens of the United States, have re- 
ceived a Corporation Charter from the State of New York. The 
Charter is issued to the Smith-Thomas Company Inc., and per- 
mits the Company to issue 5000 shares of common capital stock 
with par value of $100.00 per share. The original subscribers on 
this day give their certified checks for full payment of the shares 
subscribed as follows: Mr. Smith 100 shares, Mr. Thomas 100 



302 FUNDAMENTALS OF ACCOUNTING 

shares, and Mr. Jones 5 shares. The Company is organized and 
the treasurer accepts the checks, and issues the stock certificates. 

January 15. 

In accordance with proper action of the Board of Directors, sub- 
scriptions to 400 shares of stock have been accepted at par, pay- 
ment to be 10% with subscriptions contract, and 30% each suc- 
ceeding month until the balance is paid in full. Checks totaling 
$4000.00 are received with the contracts. 

February 15. 

Checks totaling $12,000.00 are received, being the full payment 
due on installment No. i. 

March 15. 

Checks totaling $11,850.00 are received, being payment due on in- 
stallment No. 2 from all subscribers except Mr. F. Johnson, who 
subscribed to 5 shares and who has paid his 10% down payment 
and Feb. 15 installment. 

April 15. 

Checks totaling $11,610.00 are received, being payment of install- 
ment No. 3 from all subscribers except Mr. Johnson, who de- 
faults once again, and Mr. Sherman, who also fails to remit for his 
third and final installment on 8 shares subscribed for, and upon 
which he had paid the first and second installments as well as 
the 10% down payment. All stock fully paid is issued as of this 
date. 

May i. 

Notices have been sent to both Mr. Johnson and Mr. Sherman that 
their shares will be forfeited and sold to pay for their contracts 
unless they pay within 30 days. 

May 31. 

Mr. Johnson has failed to reply, while Mr. Sherman requests that 
you sell all his shares at auction remitting to him any surplus. 
The shares are sold at auction and bring $70.00 per share for a 
total of $910.00. The expenses of sale amount to $70.00 and 
are to be charged equally to each of the defaulting subscribers. 
The shares of Johnson and Sherman are canceled and a new cer- 
tificate issued to the purchaser who bid the 13 shares at $70.00 
per share. 

Required: 

1 i ) All journal entries required to give effect to above, with proper 
explanations. Include the organization, sale of shares to the 
original subscribers, and the complete entries for the forfeiture, 
all as indicated in the description above. 

(2) Prepare ledger accounts for: 

Unissued Capital Stock ; Subscription Contracts Receivable 
(Control) ; Individual accounts for the two defaulting sub- 
scribers; an account for Forfeited Stock; and Forfeited 
Stock Surplus. 

(3) Post all journal entries affecting the accounts above. 



CHAPTER XVII 

RECORDS AND ACCOUNTS PECULIAR TO THE 
CORPORATION 

RECORDS PECULIAR TO A CORPORATION 

When a corporation starts business it must be prepared to 
operate a good set of accounting records. These records may 
be divided into two groups. The first consists of those records 
which every organization must keep in which the routine book- 
keeping is done, consisting of the usual journals and ledgers. 
The second group, as we might divide them, are those records 
which are peculiar to the corporation. The principal books in 
this latter group are: (i) The Minute Book; (2) The Stock 
Certificate Book; (3) The Stock Ledger; (4) The Transfer 
Book; (5) The Subscriptions Book. 

THE MINUTE BOOK 

This book is required by law. It has no particular form; 
any ordinary blank book will answer, and no objections should 
be raised to the loose-leaf type of book. The minute book 
should contain a brief history of the corporation in chronologi- 
cal order. Every important item of business transacted by the 
Board of Directors, or at the meetings of stockholders, 
should be recorded. The book should be started with a record 
of the first meeting of the stockholders, and followed by rec- 
ords of all subsequent regular and special meetings of the 
Board of Directors and stockholders. Unless the charter and 
by-laws of the corporation are separately bound, a copy of these 
papers may be incorporated in this book, as is often done by 
the smaller corporations. 

THE STOCK CERTIFICATE BOOK 

The up-to-date stock certificate as prepared by the leading 
bank note companies is a single instrument; that is, it is made 
up without a "stub " and is prepared in loose form, numbered 
consecutively. On the face of the stock certificate are usually 
printed the certificate number and the number of shares repre- 

303 



304 FUNDAMENTALS OF ACCOUNTING 

sented by the certificate, together with a brief legend regarding 
the corporation. The owner's name is registered and the seal of 
the corporation affixed, together with the signature of the presi- 
dent and often one other officer, such as secretary or treasurer. 
On the reverse side of the certificate is printed the standard 
assignment form, which must be filled out before the stock may 
be transferred from one owner to another. The assignment is 
made by the registered owner signing his name on the assign- 
ment form. He may " fill out " the blanks showing the name 
of the person or persons to whom he is transferring his stock, 
together with the shares assigned to each, or he may assign " in 
blank " and then the certificate may circulate freely. While 
it is in circulation, the ownership will continue to be registered 
in the name written on the face of the certificate until the new 
owner's name is filled in and the certificate presented at the 
transfer offices of the corporation. 

The regular or " stock " forms for certificates of stock are 
usually prepared in quantity by wholesale stationers, and often 
small corporations will use these ready-made certificates. 
Forms are available for both common and preferred stock. The 
stationers then simply print in the name of the corporation. 
These ready-made certificates are made up in book form, with 
a perforation for separating the actual certificate from its stub, 
on which appears the pertinent information such as the date of 
issue, in whose name the certificate is registered, and to whom 
the certificate is delivered. This procedure is still followed by 
those smaller corporations acting as their own transfer agent, 
but is not used where a bank or trust company is acting as a 
transferring agency. 

The modern method of controlling stock certificates, as prac- 
ticed by the leading trust companies, is by use of a ledger in 
which are recorded the total certificates originally received, in- 
dicating them by numbers and showing by number the daily use 
of them. In the event that any certificates are canceled in 
error, notation is also made of this fact so that the bank or trust 
company can at all times determine exactly the certificates 
outstanding in hands of holders. Certificates received for the 
purpose of transfer are, of course, canceled, record being made 
of their number and registration, and placed in the vaults of the 
bank or trust company, where they are kept for two years or 



CORPORATIONS: ACCOUNTS, RECORDS 305 

more, after which time the shares may be returned to the 
corporation for further holding, in compliance with the Statute 
of Limitations. If outstanding certificates are exchanged for 
any purpose, their cancelation on presentation is effected as 
though they were presented for purpose of transfer. The un- 
used certificates of any particular class, after their use is pro- 
hibited by resolutions of the corporation, are usually cremated 
by the bank note company which manufactured them, who also 
prepare a formal cremation certificate for the files of the cor- 
poration. 

The old method of signing stock certificates manually by 
officers of the issuing corporation is gradually becoming mod- 
ernized by the use of facsimile signatures. Legislation of some 
thirteen States at the present time authorizes the use of fac- 
simile signatures by corporations obtaining their charter in the 
particular State, and also covers the use of a facsimile seal, 
thereby eliminating a vast amount of manual labor in the sign- 
ing and affixing the corporation's seal to the stock certificates. 

THE STOCK LEDGER 

The stock ledger has likewise changed considerably from the 
old method of posting the stockholder's name and address in a 
so-called Stock Ledger. The modern bank or trust company 
uses modern labor-saving machinery which enables it to 
record the various stockholders by machine on small ledger 
sheets, which machine also computes the holdings as they un- 
dergo changes from time to time. The operation of this ma- 
chine is of such a nature as to prohibit its being explained in 
writing except to say that on the issuance of a stock certificate 
to a particular party, a record is made on a small ledger sheet 
similar to the form illustrated on the following page. 

On this form appear not only the stockholder's name, but the 
address and the number of shares held, also any information 
that might pertain to the forwarding of dividends, proxies, and 
notices of meetings. As the number of shares is diminished or 
increased, the necessary change is made on the ledger sheet, so 
that at a glance the holdings of a particular holder can be ascer- 
tained at any time. In handling some of the larger corpora- 
tions, where stockholders number around sixty to eighty thou- 
sand, the stock books are segregated as to the alphabet, pro- 



FUNDAMENTALS OF ACCOUNTING 

viding total holdings by " letter " and dividends are prepared 
in a similar manner so as to lessen errors and discrepancies. 

Form No. i 
NAME OF CORPORATION 



Certificate Surrendered 


Certificate Issued 


Credit 
Balance 


Date 


Number 


v/ 


Shares 


Date 


Number 


v/ 


Shares 
















Forward 







THE SUBSCRIPTIONS BOOK 

Beside the records just revealed, a subscriptions record is also 
maintained. If the corporation acts as its own subscription 
agency, a subscription list is usually kept, which is subse- 
quently posted to the subscription ledger which will be a per- 
manent record of all subscriptions the corporation receives from 
stockholders or the general public. Where a bank or trust com- 
pany acts as agent in the receiving of subscriptions, however, 
it has become the practice to use what is called the " subscrip- 
tion circular." This circular is prepared with name, address, 
and number of shares subscribed. Or separate contracts may 
be mailed to each prospect. After these circulars or individual 
contracts have been returned, they are arranged alphabetically, 
and serve the purpose of a subscriptions journal. 

If the corporation has been chartered before the subscrip- 
tion contracts have been signed, then the subscriptions be- 
come binding agreements between the parties thereto, and either 
the corporation or the subscriber may, if necessary, bring suit 
for specific performance. 



THE TRANSFER BOOK 



In modern practice the record of transfers of stock is accom- 
plished by the use of a Transfer Sheet or Control Sheet as it 
is known in the transfer department. An illustration of a con- 



CORPORATIONS: ACCOUNTS, RECORDS 307 

trol sheet used by the Guaranty Trust Company of New York 
is shown below. 

On this sheet is recorded full detail as to certificates surren- 
dered for transfer and the new certificates issued in lieu thereof. 
The stockholder's name appears in the column designated for 
the purpose of showing the certificate canceled and the certifi- 
cate issued, with the address showing under " certificates is- 
sued," because such holder will be a new account for the stock 
ledger. The number of shares is shown in both instances, en- 
abling the sheet to be proved in total. This sheet is made with 
one original and five copies. Copies are given to various divi- 
sions interested, including one copy to the bookkeeping depart- 
ment where proper entries are made of the transfers. A copy is 
also mailed to the principals so as to keep them advised of the 
activity of their shares and, as the case may demand, copies are 
also furnished to co-agents in cities other than that of the issu- 
ing agent. 

The undersigned, owners and holders of the shares of the CAPI- 
TAL STOCK of the above-mentioned Company, for value received, 
do hereby by our respective Attorneys duly appointed respec- 
tively assign said shares of such CAPITAL STOCK in the manner 
below set forth. 

CONTROL SHEET 



Certificates 
Surrendered 


Cert. 

No. 


No. of Shares 


Certificates 
Issued 


Cert. 

No. 


No. of 
Shares 


N.Y. 






i 










i 






2 










2 






3 










3 






4 










4 






5 










5 






6 










6 






7 










7 






8 










8 






9 










9 






10 










TO 







ACCOUNTS PECULIAR TO THE CORPORATION 

Just as certain books are peculiar to the operation of a cor- 
poration, so also are there certain accounts peculiar to the 
corporation. 



308 FUNDAMENTALS OF ACCOUNTING 

In the unincorporated company the term Net Worth refers to 
the difference between assets and liabilities. 

A-L=NW 

In the corporation the same is true, except that net worth 
now has a somewhat broader and more extensive meaning. If 
we think of the fundamental definition of net worth, we recall 
that net worth was described as the owners' equity in the busi- 
ness, and that such equity was really only an accountability, that 
the business did not owe the amount designated by net worth 
to the proprietors in the same sense that it did to the firm's 
creditors. If we can bear in mind this distinction between net 
worth and liability, we shall have no trouble in understanding 
the several accounts which make up the net worth structure 
in the corporate form of organization. In general, the Net 
Worth of a corporation is made up of two elements, the Capital 
Stock and the Surplus. The capital stock group will consist 
usually of several accounts rather than just one. It was said in 
the last chapter that care must be taken in selecting names for 
accounts dealing with capital stock. This will be evident here 
from the accounts we are now going to present. 



CAPITAL STOCK 

The Capital Stock account is created by means of the open- 
ing entry, when Unissued Capital Stock is debited and Capital 
Stock is credited. The purpose of the account is to show the 
amount of stock authorized by the charter. If more than one 
class of stock is authorized in the charter, then separate ac- 
counts for each class should be maintained, appending the ap- 
propriate designation " common " or " preferred " to the 
account title. The Capital Stock account will always have a 
credit balance as long as the corporation is in existence. It 
will be further credited with any subsequent additions to the 
authorized issue, and debited should the authorized issue be 
decreased. 

The Capital Stock account will appear under the Net Worth 
section of the balance sheet, but will be offset by the Unissued 
Capital Stock account. 



CORPORATIONS: ACCOUNTS, RECORDS 309 

UNISSUED CAPITAL STOCK 

This account, like the Capital Stock account, comes into ex- 
istence with the opening entry of the corporation. Similarly, 
there may be unissued common and unissued preferred capital 
stock; and, where both classes of stock are in use, it will be well 
to keep the two classes separate by the proper appendment of 
the word common or preferred. The Unissued Capital Stock 
account is debited in the opening entry with the total par value 
of all stock authorized, and reflects the amount of capital stock 
available for issue. As the stock is sold the account is credited 
with the par value of all shares issued. The resulting balance 
will measure the par value of all capital stock still available for 
sale. The account should not be treated as an asset on the bal- 
ance sheet, even though it has, as a matter of fact, several char- 
acteristics of an asset. It is better shown on the balance sheet 
as a deduction from the Capital Stock account, because in this 
manner it is possible for the reader of the balance sheet to see 
at a glance three things: the authorized issue, the amount still 
unissued, and the amount outstanding, of each class. This may 
be shown as follows, under the Net Worth section of the bal- 
ance sheet: 

Net Worth 

Authorized Capital Stock Common: 

10,000 shares par value $100 $1,000,000.00 

Less Unissued Capital Stock 400,000.00 

Issued and Outstanding $600,000.00 

Authorized Capital Stock &% Pre- 
ferred: 

10,000 shares par value $100 $1,000,000.00 

Less Unissued Capital Stock 250,000.00 

Issued and Outstanding $750,000.00 

In addition to this the remainder of the Net Worth section 
known as Surplus will appear. 

SURPLUS AND DEFICIT 

The Surplus account represents the excess of assets over total 
Liabilities plus Capital Stock outstanding. It is usually the 
result of accumulated earnings not distributed to the stockhold- 



310 FUNDAMENTALS OF ACCOUNTING 

ers in the form of dividends. Should the total capital stock out- 
standing exceed Net Worth in our fundamental equation, then 
there is a Deficit. This account may be shown on the balance 
sheet on the asset side in red or in italics to indicate its true 
character, and that it appears on the asset side only to balance 
the statement, or better deducted from the Net Worth section 
to agree with total assets. 

The Surplus account comes into existence at the close of the 
first accounting period, should the corporation's operations re- 
sult in a profit. The final closing entry for a corporation is a 
transfer of any credit balance in the Profit and Loss account to 
Surplus. So it is that the Surplus account measures the accu- 
mulated earnings of the corporation. Corporations may use 
several surplus accounts, but where more than one are in use, 
then all other than the General Surplus account should be ap- 
propriately labeled as Treasury Stock Surplus , Surplus for 
Advertising, both special surplus accounts explained in the last 
chapter. The General Surplus account is kept primarily for the 
purpose of exhibiting the undivided profits of a corporation. 
This account should be credited with any earnings at the close 
of the accounting period and should be debited if there is a loss 
from operations. This debit would, of course, be contingent 
upon the existence of a surplus; for, should there be no surplus 
in existence, then obviously the Deficit account must be re- 
sorted to. The Surplus account is also debited with the amount 
of any dividends declared by the corporation. The balance will 
then show the undivided profits of the corporation. 

STATEMENT OF SURPLUS 

In Chapter III a sole proprietor's Statement of Capital was 
explained and illustrated. Often in a corporation changes will 
take place in the corporation's surplus between periods. Such 
changes call for the preparation of an auxiliary statement known 
as the Statement of Surplus. 



CORPORATIONS: ACCOUNTS, RECORDS 311 

Illustration 

HAWKINS MANUFACTURING COMPANY 

Statement of Surplus, December 31, 19 

Balance at January i, ig $60,000.00 

Add Increases during period 

Error in inventory, understated January i 2,000.00 

Profit for year as per Profit and Loss Statement . . 26,410.00 

$88,410.00 
Deduct 

Additional Tax prior year $ 460.00 

Account Payable not entered 120.00 

Dividends Preferred Stock 12,000.00 

Dividends Common Stock 18,000.00 

$30,580.00 
Balance as per Balance Sheet December 31, 19 $57,830.00 

DIVIDEND ACCOUNTS 

A dividend is a distribution of part of a corporation's earnings 
to the stockholders. Dividends may be paid legally only from 
earnings. It is improper to declare dividends where no surplus 
exists, and illegal where the corporation is insolvent. Should 
dividends be paid improperly they may be recovered, for their 
payment is a fraud on the creditors. 

DIVIDENDS PAYABLE IN FOUR FORMS 

(1) Cash. The cash dividend is the most usual and is de- 
clared payable in cash when a fund of cash is available or will 
be available on the day set for payment of the dividend. Under 
certain circumstances it is proper for a corporation to borrow 
cash to pay a dividend if its immediately available cash is not 
sufficient. However, it should not impair its working capital 
by so doing or threaten the solvency of the corporation. Such 
a payment would be illegal. 

(2) Dividend Payable in Scrip. If a corporation has a 
proper surplus from which to declare a dividend, but sufficient 
cash is not available, then the Board of Directors may pay the 
dividend in scrip. Scrip is a short-term promise to pay in the 
future and is used generally when funds will be definitely avail- 
able at some early future date, as by the conversion of some 
property held by the corporation. 



312 FUNDAMENTALS OF ACCOUNTING 

(3) Bonds. A corporation may issue bonds if it likes to pay 
a dividend, or any bonds on hand might be sold and the proceeds 
used to pay a cash dividend. 

(4) Stock Dividends. In most States the payment of a divi- 
dend in the corporation's capital stock is legal. There must, of 
course, be surplus profits against which the dividend is issued. 
It is not, however, a true dividend, for it neither decreases the 
assets of the corporation nor increases the assets of those who 
receive it. As to the corporation, it merely converts surplus 
into shares of capital stock. As to the stockholder, it simply 
changes the form of his investment by increasing the number of 
shares, at the same time reducing the amount of surplus 
available for dividends. The stockholder is theoretically no 
better off, because, while he holds more shares than before 
the stock dividend was paid, the book value of each share has 
been diminished, leaving the aggregate value of all his stock 
substantially the same. Practically, however, if a sound com- 
pany declares a stock dividend, and if the same dividend rate is 
maintained in subsequent years, the market value of each share 
will drop but little and the market value of the individual's stock 
holding will be proportionately greater. 



STOCK DIVIDENDS ON NO PAR SHARES 

The nature and effect of a stock dividend declared on shares 
without par value would depend upon the conditions of each 
particular case. One thing, however, is certain: the net worth 
of a corporation paying such a stock dividend will not change. 
Such a dividend merely means that each shareholder will have 
a larger number of shares each of a proportionately smaller 
value. If, however, the Board of Directors transfer part of the 
surplus to the Capital Stock account as they presumably would, 
the result would be the capitalization of surplus as in the case 
of a dividend paid in par value stock. 

The amount to record for no par stock dividends varies be- 
cause of the different values at which no par stock is recorded 
in the Capital Stock account when issued originally. In States 
that require a minimum issuing price, it is necessary to trans- 
fer an amount equivalent to the product obtained when the 
minimum share price is multiplied by the number of shares to 



CORPORATIONS: ACCOUNTS, RECORDS 313 

be issued; the Board of Directors may, of course, authorize the 
transfer of a larger amount. 



BOARD OF DIRECTORS DECLARE DIVIDENDS 

The declaration of a dividend is within the powers of the 
Board of Directors and they may, or may not, declare dividends 
at their own discretion. The courts give the Board of Directors 
wide discretion on this point ; and, even though profits have been 
made, a court will not compel the declaration of a dividend 
unless there is very clear evidence of bad faith on the part of 
the Board. It is to be remembered, however, that a corporation 
is organized for a profit and this purpose cannot be indefinitely 
defeated by a Board of Directors. Therefore, a court of equity 
in a proper case will compel the declaration of dividends.* 

NOTICE OF DIVIDENDS 

The Board of Directors have full power to fix the time and 
the place of payment of dividends, but they must give the stock- 
holders due notice. 

Dividends are payable at a date set forth in the Board of 
Directors' declaration, and immediately become a liability or 
debt of the corporation. If a dividend is once declared, and not 
paid, a stockholder can sue as on any other debt. A dividend 
is usually made payable at a future date. It may be declared 
October isth and be payable November isth. Dividends are 
payable only to those who are stockholders at the time of its 
declaration. Usually the transfer books of a corporation are 
closed for a brief period, so that a list of the registered owners 
of the stock may be compiled and certified by the transfer agent 
to the corporation. 

DIVIDENDS ON PREFERRED STOCK 

Dividends on preferred stock must, as a rule, be declared 
upon the preferred shares if there are profits available. The 
Board of Directors has less discretion in the payment of pre- 
ferred dividends, because of the fundamental concept of the 
contract existing between the corporation and the holders of 

* Spear vs. Rockland-Rockport Lime Co., 113 Me. 285, 93 Atlantic Reporter 
754- 



314 FUNDAMENTALS OF ACCOUNTING 

preferred shares. The Board of Directors undoubtedly has 
some discretion in the matter, usually in determining whether 
or not a true profit exists, i.e., whether all proper expenses have 
been charged, including provision for doubtful accounts, and 
depreciation on the fixed assets. If the preferred capital stock 
is non-cumulative and the preferred dividend is " passed " in 
any year, the passed dividend does not carry over to succeed- 
ing years, but is lost. Such a non-cumulative preferred stock 
is obviously very undesirable. It must be remembered, as men- 
tioned previously, that preferred stock is cumulative unless 
otherwise stated. If a dividend on cumulative shares is 
" passed " and the company becomes prosperous again and 
reaches a point where dividends are available, the accumulated 
dividends on the preferred shares are a prior claim and must be 
paid or disposed of in some other way before dividends may 
be paid to the common stockholders. 

ACCOUNTING FOR DIVIDENDS 

Case i. Suppose the Thompson Manufacturing Company 
has a surplus of $20,000.00, and has outstanding 1000 shares of 
$100 par value common stock. The Board of Directors on 
April 1 5th decided to declare a dividend of six per cent payable 
in cash, to all holders of record May ist and payable May 
The entries required on the books will be as follows: 



GENERAL JOURNAL 

April isth 

Surplus $6000.00 

Dividends Payable $6000.00 

To set up the 6% dividend declared this 
day by resolution of the Board of Direc- 
tors payable May isth to holders of 
record May ist. 

May 1 5th 

Dividends Payable $6000.00 

Cash $6000.00 

To record the payment of dividend No. 

to holders of record May ist as per 

list from X Trust Company, transfer 
agent. 



CORPORATIONS: ACCOUNTS, RECORDS 315 

From these entries it will be evident that Dividends Payable 
is a liability account, and, should the corporation close its books 
before the dividends are paid, this liability would appear on the 
balance sheet. 

In this case it was assumed the Thompson Manufacturing 
Company had available cash to pay the dividend. 

Case 2. As a second case, suppose the Thompson Manufac- 
turing Company, although having a surplus of $20,000.00, has 
not $6000.00 available in cash. It may either borrow the money 
from the bank or issue scrip. Such scrip will be payable at a 
definite future time and until redeemed will constitute a lia- 
bility. The journal entries, when scrip is used, will be the same 
as for the cash dividend except that Dividend Scrip account 
will be substituted for the account Cash as the credit in the 
second entry. The corporation under these same conditions 
could also pay the dividend in stock. The entries required here 
again would be the same as before, except that the credit in the 
second entry would be made to Unissued Capital Stock, or 
Treasury Stock, as the case may be, instead of to Cash. 



BONDS 

Peculiar to a corporation, also, are the accounts required 
when the corporation issues bonds. 

Besides being able to raise funds by the sale of its capital 
stock, a corporation is also given the right to sell bonds. A 
bond might be defined as a long-time promissory note issued 
under seal by a corporation, usually secured by a mortgage on 
some fixed assets, as a guarantee of payment. 

Corporation bonds are to be distinguished from the real es- 
tate " bond and mortgage." In the real estate bond and mort- 
gage the two principals involved are the mortgagor, or the party 
borrowing, and the mortgagee, the party lending the money. 
The mortgagee holds the bond (or promissory note) and the 
mortgage. If the terms of the bond are violated, he carries the 
mortgage and may foreclose, or pursue that line of action, 
which in his judgment will best serve in enforcing the condi- 
tions of the bond and mortgage. In this respect it may be neces- 
sary to call a meeting of the bond holders to aid in determining 
the best course to follow. 



316 FUNDAMENTALS OF ACCOUNTING 

In the case of the corporation " bond " there is also a bond 
and mortgage, but obviously each bondholder could not hold 
the mortgage ; therefore, in the corporate bond, a trustee, usually 
a bank or trust company, is named to represent the bondholders 
and see that their interests are protected. 

Bonds may be registered or coupon bonds. Coupon bonds 
are bonds having attached coupons calling for the regular quar- 
terly or semi-annual payment of interest. Thus, if a company 
issues a twenty-year coupon bond, upon which the interest is 
payable quarterly, eighty coupons will be made part of the bond 
and each will bear the appropriate date and amount of interest, 
and will be clipped and presented for payment to the issuing 
corporation or its agent. Registered bonds, on the other hand, 
have no coupons attached, but are registered in the owner's 
name and regular interest checks are mailed to the registered 
owner. Bonds are usually issued in $1000. amounts although 
today " baby bonds/' those issued for $500. or $100. and even 
smaller amounts, are becoming quite popular. Coupon bonds 
are negotiable just like any bearer instrument. Registered 
bonds, although also negotiable, require a transfer of the regis- 
tration on the books of the corporation. 

When a corporation decides to issue bonds, certain legal for- 
;malities must be complied with and the laws of the State in 
which the corporation is chartered must be followed. The char- 
ter and by-laws must also be complied with. Should the cor- 
poration have an issue of preferred stock outstanding, then 
permission is usually required from that group of stockholders 
before any bonds may be authorized. 

Bonds to be listed on the New York Stock Exchange must be 
printed and engraved by an approved bank note company and 
meet other regulations as to uniform size, and registration. 
Similarly to the safeguarding of the issuance of stock, a register- 
ing agent, a bank or trust company, is given charge of the 
issuance of bonds. Bonds are numbered serially, and usually 
must be signed by two officers of the corporation issuing the 
bonds and endorsed by the bank or trust company acting as 
registrar before the issue is valid. All of this is done to protect 
the public from counterfeiting or the overissuance of bonds 
authorized. 



CORPORATIONS: ACCOUNTS, RECORDS 317 

SOME USUAL FORMS OF BONDS 

A complete classification of bonds would be a far too exten- 
sive proposition for any elementary text on accounting; there- 
fore, only the most usual forms will be briefly discussed here. 
Bonds may be generally grouped as: (i) Government bonds, 
including Federal, State, and other municipal corporation bonds, 
(2) Industrials. This group includes all private bonds except 
the third group known as (3) Utility bonds, those issued by the 
large public utility corporations. Another distinction is be- 
tween secured and unsecured bonds. So-called unsecured bonds 
are those for which no tangible assets have been pledged, 
whereas secured bonds do have particular property pledged as 
security. 

The following brief description of some of the more common 
types of bonds in use today may be helpful in our study of ac- 
counting for bonds. 

Debenture bonds. Debenture bonds are bonds not secured 
by a specific lien, that is, with no security other than the gen- 
eral assets and credits of the issuer. 

All government, state, and municipal bonds are debenture 
bonds, not being secured by mortgages or other specific pledge 
of assets. 

Private corporations, however, also use debenture bonds upon 
occasion. Their strength depends upon the general strength 
of the issuing company and the equity in the general assets over 
other bonds having prior lien. Their certainty of receiving their 
interest regularly depends upon the size and regularity of the 
excess of annual earnings over the amount required to meet 
prior charges. 

First mortgage bonds. These are, of course, secured bonds, 
and will constitute a first lien on some certain specific assets 
of the corporation. There may be a second or a third mortgage 
bond, each issue, of course, being ranked as first, second, or 
third claims against the particular assets. Bonds bearing the 
names First and Consolidated, First and Refunding, First and 
General Mortgage, are confusing because of their titles. In the 
first place, they are not first mortgage bonds in the sense that 
they represent a first lien on all the property of the issuing com- 



3i8 FUNDAMENTALS OF ACCOUNTING 

pany. They are secured by a first mortgage on a portion of 
the company's property, but on the remainder may be only 
second, third, fourth, fifth, or lesser lien, due to various ex- 
isting underlying mortgages on different parts of the property. 
They become first mortgages on other parts of the property as 
they replace older bonds either by consolidation, refunding, or 
purchase. It is the usual intent that these bonds shall eventually 
replace those of all existing mortgages and thus in reality be- 
come a first lien on the entire property. 

The term General Mortgage Bonds means bonds secured by 
a general or blanket mortgage on all the company's property, 
already subject in whole or in part to prior mortgages. 
Redeemable bonds. Bonds which by the terms of their issue 
may be called for redemption by the issuing company before the 
date of their maturity are known as redeemable or callable 
bonds. It is quite common to issue bonds which are redeemable 
at certain specified times, or within certain time limits, or upon 
certain notice. To compensate the holder for the loss of his 
investment, a redemption price somewhat above par value is 
usually set. 

Convertible bonds. Convertible bonds are those which are 
convertible at the option of the holder into other securities of 
the issuing corporation. The conversion privilege usually 
means the right to convert into preferred or common stock and 
set at a certain ratio, sometimes par for par, sometimes at a 
given figure as at no, or 102, and so forth. When a company 
issues bonds convertible into stock, it must have author- 
ized and available sufficient stock to make the conversion if 
required. 

Serial bonds. Bonds of a single issue, but made up of various 
groups with varying dates of maturity, are known as serial 
bonds. It is customary to divide the entire issue into a number 
of groups, having the groups mature successively at equally 
distant periods. The periods between maturities of the various 
groups are sometimes as small as six months and sometimes as 
long as several years. The system provides for systematic and 
gradual reduction of the issue. The entire issue bears the same 
rate of interest; hence if the bonds are sold below par and re- 
deemed at par, the yield on the shorter-term ones will be larger 
than that on those of longer terms. The yield is generally made 



CORPORATIONS: ACCOUNTS, RECORDS 319 

uniform by arranging a varying scale of prices which constantly 
diminishes as the terms of the bonds increase. 
Sinking fund bonds. These are bonds issued under an agree- 
ment whereby the issuing corporation is required to set aside 
regularly out of earnings a sum which, with interest, will be suf- 
ficient to redeem the bonds at maturity. This gives the bond- 
holders absolute assurance of a systematic provision for 
repayment of the loan. The sinking fund payments are obliga- 
tory, and failure to make them gives the bondholders the same 
rights as would default in an interest payment. 

ACCOUNTING FOR BONDS 
ORIGINAL ISSUE 

After all the formalities of the issue have been met, the fol- 
lowing journal entry, placing the authorized issue of bonds on 
the books, should be made : 

i 

Unissued Bonds $500,000.00 

Bonds Authorized $500,000.00 

To record the authorized issue of 
500 coupon bonds par $1000. In- 
terest 7% payable February isth 
and August isth, see Board of Di- 
rectors' resolution minute book, 
p. 56. 

This entry will place the issue of bonds on the books in the 
same manner as the opening entry for the corporation places the 
authorized issue of stock on the books. 

The use of Bonds Authorized and Unissued Bonds accounts 
is advocated because not infrequently part of the issue will not 
be offered for sale; and, unless these accounts are used, the 
amount of bonds authorized and unissued may not be exhibited 
on the balance sheet. 

Very frequently old established corporations have no trouble 
in " floating " their bonds and quite often a bank or investment 
house will buy the entire issue. The investment bankers may 
get the issue at par or below par, or under certain circumstances 
pay a slight premium. Premium and discount accounts will 
be discussed later. If the entire issue is sold outright for cash 
the only entry required is: 



320 FUNDAMENTALS OF ACCOUNTING 

-2- 

Cash $500,000.00 

Unissued Bonds $500,000.00 

To record sale of entire issue to X 
Investment Bankers at par. 

Throughout this chapter the accounts used are purposely 
simplified. Long descriptive titles such as First Mortgage Re- 
funding Seven Per cent Bonds Authorized, as used in actual 
practice, are not essential to an understanding of the principles 
involved, and are therefore simplified as in the last two journal 
entries. 

BONDS SOLD ON INSTALLMENTS 

In many instances bonds will be sold on subscription very 
much as stock is sold, and for all practical purposes the account- 
ing is the same. When bonds are sold, however, they are usu- 
ally sold at a certain price plus accrued interest. This is be- 
cause the purchaser will receive any interest which has accrued 
on the bond when he collects his first coupon or receives his first 
interest check if the bond is registered. The accrued interest 
is most conveniently calculated when the final payment is made 
and added to that. The bond is then turned over to the 
purchaser. 

The journal entries on the following page will illustrate the 
sale by subscription of 100 coupon bonds, $1000. par, and 6% 
interest payable May ist and November ist. The subscriptions 
contract is executed May 3 ist and calls for a 50% down pay- 
ment with the balance payable 60 days after date. 

The student will note that the bondholder has paid $1500.00 
in accrued interest. When he collects his first coupons No- 
vember ist, he will receive $3000.00 which represents the half 
year's interest on the bonds, which he may consider as a return 
of the $1500.00 he paid, plus an equal amount earned from 
July 3oth to November ist, the time he has held the bond. 
In actual practice the accrued interest must be calculated for 
each sale and added to the price paid for the bonds, unless, of 
course, they are bought on the interest date. 



CORPORATIONS: ACCOUNTS, RECORDS 321 

JOURNAL 

May 3ist 
Bond Subscriptions Receivable . . . $100,000.00 

Bonds Subscribed $100,000.00 

To record the receipt of a subscrip- 
tion for 100 bonds at $1000, plus 
accrued interest, 50% cash is re- 
ceived, balance due in 60 days. 

May 3ist 

Cash 50,000.00 

Bond Subscriptions Receivable . 50,000.00 

To record the receipt of 50% down 
payment on above subscription. 

July 30th 
Cash 51,500.00 

Bond Subscriptions Receivable . 

Interest Accrued on Bonds .... 
To record the receipt of final pay- 
ment of $50,000.00 plus the accrued 
interest from May ist to July 3oth 
(90 days on $100,000 = $1,500). 

July 30th 

Bonds Subscribed 100,000.00 

Unissued Bonds 100,000.00 

To record the issue of 100 bonds, 

serial numbers , etc., final 

payment received above. 

When the corporation pays the $3000 coupons to the pur- 
chaser, it will make the following entry: 

November ist 

Interest Accrued on Bonds $1,500.00 

Bond Interest 1,500.00 

Cash $3,000.00 

For payment of bond interest. 



50,000.00 
1,500.00 



BOND PREMIUM AND DISCOUNT 

It is not frequent that an issue of bonds can be disposed of 
at exactly their par value; more often they will be sold below 
or above par. When sold below par the difference is known as 
bond discount, while any amount received over par value is 
known as premium on bonds. There are many reasons for 



322 FUNDAMENTALS OF ACCOUNTING 

bonds selling below and above their par or face value; some- 
times it is the relative strength of the issuing corporation which 
will vary the price received for bonds offered for sale. The most 
important factor causing a variance in the sales price above or 
below par, however, is the value of money at the time of the 
issue. If money is worth six per cent and a corporation wishes 
to float an issue of five per cent bonds, everything else being 
equal, the bonds must sell at a discount, and similarly if money 
is worth only five per cent and a company floats an issue of six 
per cent bonds the issue will sell at a premium. 



ACOUNTING FOR BOND PREMIUM 

Suppose the Hawkins Manufacturing Company is issuing 
$100,000. worth of 2O-year bonds upon which 6% interest is to 
be paid January ist and July ist, and suppose the company is 
offered $112,500. for the issue. The journal entries to record 
the sale will be as follows : 

Cash $112,513.00 

6% Bonds Payable $100,000.00 

Premium on Bonds 12,513.00 

To record the sale of 100 6% 

bonds, coupons payable January ist 

and July ist at $1125.13 each. 

When this entry is made, the Premium on Bonds account is 
set up with a credit balance. Each interest period, as the com- 
pany pays the 3% interest on the $100,000 worth of bonds, the 
following entries should be made: 

GENERAL JOURNAL 

Bond Interest $ 3000.00 

Cash $ 3000.00 

To record the payment of Coupon 
No. i. 



Premium on Bonds 312.82 

Bond Interest 312.82 

To write down bond interest by 
one-fortieth of the premium re- 
ceived on sale of bonds. 



CORPORATIONS: ACCOUNTS, RECORDS 323 

If these entries are made at each interest period, the bond 
premium will be spread equally over the forty periods or twenty- 
year life of the bonds, thus reducing the actual interest paid for 
the use of the money to about 5 % . This straight line method 
of apportioning the bond premium or discount is quite often 
followed in actual practice, but a more scientific calculation is 
sometimes made of the amortization of premium or discount 
on bonds. There are several books published giving bond 
tables, values, and yields at different costs for all regular types 
of bonds. It is therefore not ordinarily necessary for the ac- 
countant to compute any of these amounts any more than it is 
necessary or desirable for him to calculate interest as long as 
interest tables are available. It is essential, however, that every 
accountant understand how these values are calculated. The 
accounting student will get an introduction to the mathematics 
of accounting in Advanced Accounting for most second-year 
courses include some work in this very interesting field. There 
are also several good texts devoted to the mathematics of ac- 
counting and finance and many schools offer courses in this 
work. Those who wish to look ahead at this time may consult 
Sprague's Extended Bond Tables, or any standard text on the 
mathematics of accountancy. 



ACCOUNTING FOR BOND DISCOUNT 

Suppose the Hawkins Manufacturing Company plans to issue 
$100,000. worth of 20-year bonds as before, except that the 
interest rate is to be only four per cent. Investment bankers 
will not be willing to pay par, if money is worth five per cent; 
they will expect a discount. Suppose they pay $87,448.00 for 
the issue. The entries which the Hawkins Manufacturing 
Company should make are as follows : 

Cash $ 87,448.00 

Bond Discount 12,552.00 

4% Bonds Payable $100,000.00 

To record the sale of 100 4% 
bonds, coupons payable Jan. ist 
and July ist at $874.48 each. 

The bond discount will have exactly the opposite effect on the 
actual interest cost to what the premium on bonds account had. 



324 FUNDAMENTALS OF ACCOUNTING 

It will tend to increase the interest cost and should be amortized 
as follows : 

Bond Interest $ 2000.00 

Cash $ 2000.00 

To record the payment of Coupon 
No. i. 



Bond Interest 313.80 

Bond Discount 313.80 

To write down the bond discount 
by one-fortieth and increase the in- 
terest cost. 

This treatment of the bond discount is the straight line 
method similar to that used in amortizing the bond premium 
in the first case. 

Other accounts are met with in the treatment of bonds, such 
as the creating of sinking funds, but this and several other 
topics relating to both stocks and bonds more properly belong 
in the realm of advanced accounting. 

One other account, however, which should be treated before 
this chapter is closed is the Organization Expense account. 

ORGANIZATION EXPENSE 

When a corporation is organized, certain definite and very 
necessary expenses must be met. Several, such as the cost of 
preliminary surveys, examinations and the like, must be paid, 
or payment guaranteed, before the corporation itself comes into 
legal existence. The men primarily interested in the formation 
of the corporation are jointly and severally liable for any such 
debts, and, should the charter not be granted, the organizers 
would have to pay all these expenses, without hope of reim- 
bursement. Many other expenses will be required before the 
corporation can function as a well organized business. These 
will include the incorporation fee paid to the State, the legal 
fees, salaries and commissions paid to salesmen for obtaining 
subscriptions and selling the stock, and further for engraving 
the certificates, and purchase of an appropriate seal. 

In short, all expenses necessary to the proper organization 
of the corporation may be charged to Organization Expense, 
This account, although given the definite title of " expense" 



CORPORATIONS: ACCOUNTS, RECORDS 325 

may properly and legally be carried as a deferred asset on the 
balance sheet, rather than be charged off to profit and loss as 
any ordinary expense would. Conservative accounting theory, 
while agreeing that this expense account may be properly listed 
as a deferred asset or as a deduction in the Net Worth Section, 
insists, nevertheless, that it must be written off against profits 
just as soon as it is possible, usually within a period of from 
three to five years. This write off taking place at a period 
subsequent to the incurring of the expense must be made against 
the Surplus account. 

Thus, while the account Organization Expense, which very 
often represents a large amount, may be listed as a deferred as- 
set, such listing should be temporary, and is permitted only be- 
cause to charge this entire amount against the operations of the 
first accounting period would be rather unfair, when the benefits 
of sound organization are really shared in by all future periods. 



QUESTIONS ON THE CHAPTER 

1. (a) How is the Minute Book related to the books of record? 
(6) Explain its importance legally. 

2. (a) Explain the form and operation of the Stock Certificate 
Book. 

(b) Describe a share of stock and tell some of the precautions 
taken to prevent its counterfeiting and overissue. 

3. (a) Draw a diagram of a form you would advocate that a trust 
company use to record the number of shares held by each stockholder. 

(b) Explain the function and the operation of the columns 
used. 

4. How does the trust company handle transfers of stock? Is 
the corporation interested in this operation? How does the trust com- 
pany aid in this regard? 

5. Differentiate between the "Authorized" and "Unissued" 
Capital Stock accounts. 

6. Explain the make-up of the Net Worth section of a corporation 
balance sheet. Bring out the difference between Capital Stock and 
Surplus. 

7. If the total assets of a corporation are not equal to the total 
liabilities plus the capital stock issued and outstanding, what will the 
difference represent? 

8. The X Corporation has a surplus of $25,000.00 earned in the 
current year and an issue of common capital stock of $1,000,000. out- 
standing. 



326 FUNDAMENTALS OF ACCOUNTING 

The Board of Directors have not declared any dividends for 
the past three years and now refuse to declare any dividends. 

M, a stockholder, is dissatisfied and asks you if it is not pos- 
sible for him to compel the corporation to declare a dividend. 

Comment. 

9. The T and E Corporation with $100,000. capital stock issued 
and outstanding has an earned surplus of $10,000. and wishes to de- 
clare a 6% dividend. 

(a) Assume it has only $3600. available cash, but that $7000. 
in notes receivable will mature within 90 days. The company does 
not wish to delay the payment of the dividend more than thirty days. 
What would you suggest? 

(b) Assume the same facts but that the company has $20,000. 
worth of treasury stock and wishes to pay the 6% dividend in stock. 
Explain the procedure. Are the stockholders any better off? Sup- 
pose the shares are listed on the stock exchange and, before the stock 
dividend was declared, were selling at $102.00 per share. What will 
the effect of the dividend have on the market price of the shares? 

10. The Cronk Manufacturing Company, Inc., has an earned sur- 
plus of $25,000. It has $100,000. in $100. par common stock and 
$100,000. in 6% cumulative preferred stock. 

(a) It has not paid dividends to either class of stockholders for 
the past two years. The Board of Directors now feel safe in declar- 
ing a dividend to both classes of stock. What is the amount which 
(at the end of three years) the company must now pay to the pre- 
ferred shareholders? 

(b) How much is available for the common stockholders? 

11. Presume the same facts as in Question 9. The Board of Di- 
rectors feel it unwise to pay any dividends at the present time. 

(a) What can the preferred stockholders do about it? 

(b) Would your answer be the same if the preferred stock were 
non-cumulative ? 

12. Presume the Cronk Manufacturing Company, Inc., has the 
same amounts of stock as before, $100,000. each of common and pre- 
ferred. The preferred is 6%, and the company makes net profits as 
follows: end of the first year, $5000.00; end of the second year, $10,- 
ooo.oo ; end of the third year, $15,000.00. What is the largest 
dividend possible for each class of stock, presuming the preferred 
stock is: 

(a) Non-cumulative and non-participating. 

(b) Cumulative and non-participating. 

(c) Cumulative and participating equally with common after 
each class shall have received 6%. 

13. What do you understand by a corporation bond? 

(a) Definition. 

(b) How may bonds be classified? 

14. Name and describe three different forms of bonds. 



CORPORATIONS: ACCOUNTS, RECORDS 327 

15. (a) Why may bonds sell at a premium? 
(b) Why may bonds sell at a discount? 

16. (a) How may bond premiums be amortized? 
(b) How may bond discount be amortized? 

17. Explain the function of the Organization Expense account. 



PROBLEM MATERIAL 

PROBLEM i 

The H. Dover Co., Inc., had a balance in Surplus at December 31, 
1939, of $42,712.60. 

On April 1 5 the Company paid an income tax claim affecting the 
last two years for a sum of $1250.00. 

May 15 the Company disposed of a piece of Real Estate for 
$3500.00, which was carried on the books at $1000.00. 

November 15 the Company had to trade an old truck toward a new 
truck for $500.00, which was carried on the books at $750.00 net of 
accrued depreciation to date of turn in. 

November 30 the Company paid dividends of $12,000.00. 

You are a public accountant and have been engaged by the Dover 
Co. to audit their books and prepare proper financial statements. 
The bookkeeper explains that he has closed all accounts as best he 
could, leaving a credit balance in the Profit and Loss Summary Ac- 
count indicating a net profit of $14,720.80. He explains that he was 
not certain regarding the listed transactions above and wishes to re- 
view the following treatment: 

1. April 15 he debated an account called " Tax Loss/' which he 
closed to Profit and Loss Summary. 

2 . The May 1 5 Real Estate gain was closed to Profit and Loss Sum- 
mary. 

3. The Nov. 15 entries were all handled correctly except that the 
$250,000 loss on trade of autos was closed to the Profit and Loss 
Summary as a current loss. 

4. A Dividends Account was still open with a debit of $12,000.00, 
the result of the following journal entries: 

Dividends $12,000.00 

Dividends Payable $12,000.00 

6% dividend declared on C. S. 

Dividends Payable $12,000.00 

Cash $12,000.00 

To record payment of dividends. 

In addition to the facts above your audit of the Dec. 3 1 Inventory 
indicates that it was overstated by $360.00. 



FUNDAMENTALS OF ACCOUNTING 



Required: 

1 i ) All journal entries to correct the foregoing, and close the final 
correct profit to surplus. 

(2) Open the Profit and Loss Summary account with the book- 
keeper's balance and post the correction entries, and the entry 
to close the correct profit to surplus. 

Open a Surplus account with the 1939 balance, post any entries 

affecting and balance at December 31, 1940. 

Prepare a Statement of Surplus as of December 31, 1940. 



(3) 



(4) 



PROBLEM 2 



The Goodwin Corporation plans to issue $200,000.00 of 2o-year 
first mortgage coupon bonds, interest payable semi-annually April ist 
and October ist. 

An Underwriter offers the Corporation $196,000.00 for the issue if 
the Company will issue the bonds as 5% bonds, or will pay $232,- 
ooo.oo for the issue if the Company will issue 6% bonds. 

Required: 

1 i ) Which is the better offer for the corporation? Explain the cal- 
culations for Offer No. i and Offer No. 2, using the straight line 
method for the amortization of bond discount and bond pre- 
mium. 

(2) Assume the bonds are to be issued April ist, at the more at- 
tractive offer. Give journal entries for (i) Authorization of 
the issue, (2) Sale to underwriters, (3) Payment of first cou- 
pons including the amortization of the premium or discount. 

PROBLEM 3 

Assume that Franklin and Marshall are partners, sharing profits 
and losses equally, and their balance sheet at December 31 is as fol- 
lows: 

FRANKLIN AND MARSHALL 

Balance Sheet, December 31, 19 



Assets 




Liabilities and Net Worth 


Cash 
Notes Receivable 
Accounts Receivable 
Inventory 
Sundry Assets 


$ 6,500.00 
3,000.00 
14,000.00 

20,000.00 
1,500.00 


Liabilities 
Accounts Payable $ 6,000.00 
Notes Payable 1,000.00 

Net Worth 






J. Franklin Capital 20,000.00 
F. Marshall Capital 18,000.00 


$45,OOO.OO 


$45,000.00 



They decide to incorporate as Franklin-Marshall Inc., with a total 
capital of $200,000.00 divided into 2000 shares of common stock par 



CORPORATIONS: ACCOUNTS, RECORDS 329 

value $100.00. In anticipation of later selling stock to others they 
decide to add Good-will to the books, calculated to be worth $10,- 
ooo.oo, before the Corporation is formed. 

In the application for Charter Mr. J. Franklin subscribed for three 
shares, Mr. F. Marshall five shares, and Mr. J. Franklin, Jr., two 
shares. 
January 15. 

The approved charter was received, and certified checks were paid 
in by the three original subscribers, as full payment at par for 
their shares. 
January 16. 

A check for $300.00 is drawn to T. Lynch, an attorney, for legal 

services and fees in organizing the Corporation. 
January 20. 

The Board of Directors pass a resolution authorizing the purchase 
of the business conducted by Mr. Franklin and Mr. Marshall in 
partnership. The former partners agree to accept shares of capi- 
tal stock at par for their equities in the partnership. 

Required: 

1 i ) The journal entry to place Good-will on the partnership books. 

(2) Entries required for the organization of the corporation, sale 
of stock to the original incorporators, payment of organiza- 
tion costs. 

(3) Entries required for taking over the assets of the partnership 
and liabilities assumed in the purchase of the partnership busi- 
ness. New books are to be opened by the corporation. 

(4) A balance sheet for the corporation after all Journal entries 
have been posted. 

PROBLEM 4 

March i. 

Assume Franklin-Marshall Inc. have offered their stock to the 
public for subscription at par on the following terms: 10% cash 
with contract, balance 30% April i, 30% May i, and the final 
30% June i, and have this day accepted subscription to 500 
shares. 
March 15. 

J. Franklin and F. Marshall each donate 50 shares of their stock 
to be held in the Treasury and later sold to buy a plant site for 
a factory building soon to be erected. 
April /. 

First stock installment received in full. 
April 15. 

The corporation sells 100 shares of the donated stock to K. Wil- 
liams at $80.00 per share. 

The corporation buys a five-acre tract of land from the Newman 
Developing Co. for $8000.00. 



330 FUNDAMENTALS OF ACCOUNTING 

May /. 

The corporation has just completed negotiations with the Baltimore 
Finance Co. to float a $100,000.00 bond issue. The Bonds are 
drawn as 4?% coupon bonds with interest payable May ist and 
November ist. The bonds are given to the Baltimore Finance 
Co. and their check for $96,000.00 is received. 
The second installment on stock subscriptions are received in full. 
May 5. 

The American Bank Note Company's $75.00 invoice for printing 

bonds is approved and paid. 
May 8. 

A bill from T. Lynch for legal services in effecting loan from the 

Baltimore Finance Co. is approved and paid $150.00. 
June i. 

The final installment is received from all subscribers and their cer- 
tificates issued. 

Required : 

1 i ) All journal entries required for the facts above. 

(2) Balance sheet after all the foregoing entries have been posted. 



CHAPTER XVIII 
THE THEORY OF CORPORATIONS APPLIED 

The purpose of this chapter is to present a problem involving 
as many factors as possible in the organization and operation of 
a corporation. The complete solution of the problem will then 
be given, including all Journal entries and accounts required, to- 
gether with a Trial Balance of the Ledger and a Balance Sheet. 

This is done in order to unify, and to impress upon the stu- 
dent, some of the more important theories of corporations 
touched upon in the two previous chapters. 

In carrying out this purpose let us suppose that Mr. Emerson 
and Mr. Martin, who have been conducting an office supply 
business as partners, plan to expand the business and manufac- 
ture a check-protecting device, which Mr. Emerson has pat- 
ented. They wish to incorporate, and they interest Mr. Thomas, 
an attorney, who consents to aid them in the organization and 
also put some money into the enterprise. 

The new firm is to be known as the E. M. Office Supply Com- 
pany and is organized under the laws of the State of New York. 
It is chartered October ist, to issue 2000 shares of common 
stock and 2000 shares of 6% preferred stock, each with a par 
value of $100.00. 

Mr. Emerson subscribes to 300 shares, Mr. Martin subscribes 
to 300 shares, and Mr. Thomas subscribes to 100 shares of the 
common stock; all subscriptions are at par, and checks in the 
proper amounts are received with each subscription. 
October 2. The first meeting of the stockholders is called and 
Mr. Thomas, Mr. Emerson, and Mr. Martin are elected to the 
Board of Directors. Mr. Emerson is elected to the office of 
President and General Manager, Mr. Martin, Vice-President in 
charge of Sales; while Mr. Thomas is to act as Treasurer, and 
legal adviser to the corporation. 

At this meeting it is voted that the following debts be paid: 

i. To Russell Bank Note Company $300.00 for engraving 
stock certificates and furnishing other miscellaneous supplies. 

2. To the F. Audit Company for accounting services, clos- 



332 



FUNDAMENTALS OF ACCOUNTING 



ing the partnership books and opening the corporation records, 
$500.00. 

3. To Mr. Thomas, $1200.00 for fees paid to the State for 
charter and other organization expenses. Mr. Thomas agrees 
to accept twelve shares of common stock for this debt. 

At the same meeting it is also agreed that the business op- 
erated by Emerson and Martin be taken over. The balance 
sheet certified to by the F. Audit Company exhibited below is 
to be used as the basis of the purchase. Mr. Emerson and Mr. 
Martin both agree to accept common stock at par for their 
equities in the partnership. 

EMERSON AND MARTIN 
Balance Sheet, September 30, 19 



Assets 




Liabilities 




Cash 


$ 3,642.00 


Notes Payable 


$ 8,000.00 


Accounts Receivable 


19,824.00 


Accounts Payable 


12,106.00 


Inventory Furniture (cost) 


24,200.00 






Inventory Supplies (cost) 


3,640.00 


Net Worth 




Delivery Equipment 
(cost less depreciation) 
Insurance Unexpired 


720.00 
80.00 


Mr. Emerson, Capital 
Mr. Martin, Capital 


18,000.00 
14,000.00 




$52,106.00 




$52,106.00 



The transfer is accomplished and the new books opened. 
October 3. The Board of Directors agree to offer their com- 
mon stock for sale and to engage Mr. Field, a stock salesman, to 
solicit subscriptions from a selected list of friends of the cor- 
poration. Mr. Field is to get no salary but will receive three 
per cent of all subscriptions he secures. The subscriptions are 
to be at par, payable 20% with the subscription and the bal- 
ance in four monthly installments, November 15, December 15, 
January 15, and February 15, respectively. 
October 6. The Board of Directors by resolution agree to 
purchase the patent rights for the manufacture of the check 
protector from Mr. Emerson. The agreed price is $50,000.00, 
payable in preferred stock at par plus one dollar in cash for 
each check protector sold. Mr. Emerson agrees and turns over 
the patent rights to the corporation. Mr. Thomas bills the cor- 
poration $50.00 for legal services in effecting the transfer, and 
is paid in cash. Five hundred shares of the preferred stock are 
issued to Mr. Emerson in full payment. 



THEORY OF CORPORATIONS APPLIED 333 

October 10. Mr. Emerson donates back to the corporation 
200 shares of the preferred stock to be held in the treasury, and 
sold later to provide a fund to advertise the check protector. 
October 15. Mr. Field has completed his canvass of the list 
furnished him and submits the following subscription list : 

W. Boyd 20 shares B. Potter 25 shares 

B. Smith 20 shares S. Mitchell 25 shares 

C. Haven 10 shares T. Chellis 50 shares 

R. Booth 50 shares 

together with checks for the proper down payments in each case. 

The Board of Directors agree to discontinue the canvass for 
subscriptions and pay Mr. Field $600.00 in cash for his services. 
October 30. The Board of Directors have agreed to offer an 
issue of 6% bonds to the public to secure funds with which they 
are to erect and equip ^ a building for the manufacture of the 
check protector. They authorize an issue of 1000 6%, 2o-year 
bonds of $100.00 denomination, with coupons payable Novem- 
ber 1 5 and May 1 5 of each year, to be secured by a mortgage on 
the building when erected. 

Mr. Thomas arranges with the Philadelphia Investment Com- 
pany to take the entire issue at $96.00 each, payable November 
15 when the bonds are to be issued. 
November 5. Call No. i is sent out to all subscribers. 
November 15. The Russell Bank Note Company delivers 
the 1000 bonds with their bill for services in amount of $50.00, 
which is paid in cash. The bonds are delivered to the invest- 
ment banker and his check for $96,000.00 is received. The 
second installment is received. 

November 18. The board of Directors vote to sell 100 shares 
of the treasury stock preferred to A. Johnson at $98.00 per 
share, and place the cash in a special fund to be used to defray 
the advertising campaign about to be started. The sale is con- 
summated and Mr. Johnson's check for $9800.00 is received 
and the stock issued to him. 

OCTOBER 

T 

Unissued Common Capital Stock $200,000.00 

Authorized Common Stock $200,000.00 

Unissued Capital Stock, 6% Preferred . 200,000.00 
Authorized Capital Stock, 6% Pref'd. 200,000.00 



334 



FUNDAMENTALS OF ACCOUNTING 



To record the authorized issue of 2000 
shares of common stock, par value 
$100.00, and 2000 shares of 6% Pre- 
ferred stock, par value $100.00. 



Cash $ 70,000.00 

Unissued Common Capital Stock ... $ 70,000.00 

To record the subscription and issue of 

300 shares of common to Mr. Emerson; 

300 shares of common to Mr. Martin, 

and 100 shares to Mr. Thomas, all at 

par, and paid by check. 

-2- 

Organization Expense 2,000.00 

Cash 800.00 

Unissued Common Capital Stock . . . 1,200.00 

To record the payment of organization 

expenses as follows : 

Russell Bank Note Co. . . $ 300.00 

F. Audit Co 500.00 

M. Thomas 12 shares C. S. 1,200.00 

Cash 3,642.00 

Accounts Receivable 19,824.00 

Inventory of Furniture 24,200.00 

Inventory of Supplies 3,640.00 

Delivery Equipment 720.00 

Insurance Unexpired 80.00 

Notes Payable 8,000.00 

Accounts Payable 12,106.00 

Mr. Emerson 18,000.00 

Mr. Martin 14,000.00 

To record the acquisition of assets and 
liabilities of the Emerson and Martin 
partnership purchased as per resolution 
of Board of Directors (see Minute 
Book), and to credit the net value to 
Mr. Martin and Mr. Emerson as above. 



Mr. Emerson 

Mr. Martin 

Unissued Common Capital Stock . . . 
To record payment of equities incurred 
in purchase of business of Emerson and 
Martin. See resolution of Board of Di- 
rectors and entry above. 



18,000.00 
14,000.00 



32,000.00 



THEORY OF CORPORATIONS APPLIED 335 

-6- 

Patent Rights $ 50,000.00 

Unissued 6% Preferred Capital Stock $ 50,000.00 

To record the purchase of the patent 
rights for the manufacture of the check 
protector from Mr. Emerson, payable in 
500 shares of 6% preferred stock. See 
resolution in Minute Book. 



Organization Expense 50.00 

Cash 50.00 

To record the payment of $50 to Mr. 
Thomas, for legal services in effecting 
the transfer of patent rights on check 
protector. 

-IO- 

Treasury Stock Preferred 20,000.00 

Surplus for Advertising 20,000.00 

To record receipt of 200 shares of 6% 
preferred stock from Mr. Emerson, do- 
nated by him to create a fund for ad- 
vertising the check protector. 

-15- 
Subscriptions Contracts Receivable . . . 20,000.00 

Common Capital Stock Subscribed . . 20,000.00 

To record the subscriptions of 200 
shares of Common Capital Stock re- 
ceived this day as follows: 

W. Boyd 20 shares 

B. Smith 20 shares 

C. Havens 10 shares 

R. Booth 50 shares 

B. Potter 25 shares 

S. Mitchell 25 shares 

T. Chellis 50 shares 



Cash 4,000.00 

Subscriptions Contracts Receivable . 4,000.00 

To record the 20% down payment re- 
ceived with above subscriptions. 



Organization Expense 600.00 

Cash 600.00 

To record payment of 3% commission 
to Mr. Field for $20,000. subscriptions 
received by him and recorded this day. 



336 



FUNDAMENTALS OF ACCOUNTING 



-30- 

Unissued Bonds 20 years 6% $100,000.00 

2o-year 6% First Mortgage Bonds . . 
To record an authorized issue of 1000 
2O-year, 6% First Mortgage Bonds, par 
value $100, coupons payable November 
15 and May 15 of each year. To be sold 
and proceeds to erect and equip a build- 
ing for the manufacture of the check 
protector. 

NOVEMBER 



$100,000.00 



Cash 

Bond Discount 

Unissued Bonds, 2o-year, 6% 

To record the sale of above bonds at 
$96.00 to the Philadelphia Investment 
Company, delivered this day. Certified 
check in amount of $96,000.00 received 
and deposited. 

-15- 

Organization Expense 

Cash 

To record payment of invoice to Russell 
Bank Note Company for printing and 
engraving of bonds. 



Cash 

Subscriptions Contracts Receivable . 
To record the receipt of $4,000 in cash 
from subscribers' second installment due 
this day. 

-i 8- 

Cash Advertising Fund 

Surplus for Advertising 

Treasury Stock Preferred 

To record the sale of 100 shares of treas- 
ury stock. Cash to be used to defray 
costs of advertising; deposited in spe- 
cial account. 



96,000.00 
4,000.00 



100,000.00 



50.00 



50.00 



4,000.00 



4,000.00 



9,800.00 
200.00 



10,000.00 



THEORY OF CORPORATIONS APPLIED 



337 



UNISSUED COMMON CAPITAL STOCK 



Oct. i To record author- 


Oct. i To record the is- 




ized issue of com- 


sue of 700 shares 




mon stock, 2,000 


to original sub- 




shares, par $100 $200,000.00 


scribers 


$70,000.00 




i To record issue to 






Mr. Thomas pay- 






ment on fees, etc., 






Organization Ex- 






penses 


1,200.00 




2 Issue to Emerson 






& Martin for part- 






nership equities 


32,000.00 



AUTHORIZED COMMON CAPITAL STOCK 



Oct. i To record author- 
ized issue of com- 
mon stock, 2,000 
shares, par $100 $200,000.00 



UNISSUED C.S. 6% PREFERRED 



Oct. i To record author- 
ized issue of pre- 
ferred stock 2,000 
shares par $100 $200,000.00 



Oct. 6 To record issue of 
500 shares to Mr. 
Emerson for pat- 
ent rights 



$50,000.00 



AUTHORIZED C.S. 6% PREFERRED 



Oct. i To record author- 
ized issue of 
preferred, 2,000 
shares, par $100 $200,000.00 



CASH 



Oct. 



1 Rec'd. from origi- 
nal subscribers 

2 Transfer of cash 
from partnership 

15 To record receipt 
of 20% down pay- 
ment on stock 
subscriptions 

15 To record check 
received from sale 
of bonds 

Nov. 15 Records 2nd in- 
stallment on sub- 
scriptions 



Oct. 
Oct. 



Nov. 



$70,000.00 
3,642.00 



4,000.00 



96,000.00 



4,000.00 



Oct. 



i Check Nos. i and 
2, payment of or- 
ganization ex- 
pense 

6 Legal fees to Mr. 
Thomas for trans- 
fer of patent rights 
15 To Mr. Field 3% 
commission on 
$20,000.00 sub- 
scriptions 

Nov. 15 For printing of 
1,000 bonds 



Oct. 



Oct. 



'.00 

50.00 

600.00 
50.00 



338 



FUNDAMENTALS OF ACCOUNTING 



ORGANIZATION EXPENSE 



Oct. i To record pay- 
ment of organiza- 
tion expense; $300 
Russell Bank 
Note; $500 F. 
Audit Co.; $1200 
stock to Mr. 
Thomas $2,000.00 

Oct. 6 For legal fees in 
transfer of patent 
rights 50.00 

Oct. 15 For 3% commis- 
sion on $20,000 
subscriptions 600.00 

Nov. 15 For printing of 

bonds 50.00 



ACCOUNTS RECEIVABLE 



Oct. 2 Balance from part- 
nership $19,824.00 



INVENTORY OF FURNITURE 



Oct. 2 Balance from 

partnership $24,200.00 



INVENTORY OF SUPPLIES 



Oct. 2 Balance from 

partnership $ 3,640.00 



DELIVERY EQUIPMENT 



Oct. 2 Balance from 

partnership $ 720.00 



TIRE INSURANCE UNEXPIRED 



Oct. 2 Balance from 
partnership 



$ 80.00 



NOTES PAYABLE 



Oct. 2 Balance from 

partnership $ 8,000.00 



THEORY OF CORPORATIONS APPLIED 339 

ACCOUNTS PAYABLE 



Oct. 2 Balance from 
partnership 



$12,106.00 



MR. EMERSON 



Oct. 2 To record pay- 
ment by issue of 
1 80 snares of 
common stock $18,000.00 

MR. IV 


Oct. 2 For equity in 
partnership $18,000.00 

IARTIN 


Oct. 2 To record pay- 
ment by issue of 
140 shares of 
common stock $14,000.00 

PATENT 


Oct. 2 For equity in 
partnership $14,000.00 

RIGHTS 



Oct. 



6 Issue of 500 
shares of 6% pre- 
ferred payment 
of patent rights 
to check pro- 
tector 



$50,000.00 



TREASURY STOCK PREFERRED 



Oct. 10 To record dona- 
tion of 200 shrs. 
pref'd from Mr. 
Emerson 



$20,000.00 



Nov. 1 8 Sale of 100 shares $10,000.00 



SURPLUS FOR ADVERTISING 



Nov. 1 8 Discount on sale 

of 100 shares $200.00 



Oct. 10 



To record the do- 
nation of 200 
shares preferred 
to hold for ad- 
vertising fund 



$20,000.00 



SUBSCRIPTIONS CONTRACTS RECEIVABLE 



Oct. 15 To record sub- 
scription to 200 



shares 



$20,000.00 



Oct. 15 20% cash pay- 
ment 
Nov. 15 2nd payment 



$ 4,000.00 
4,000.00 



COMMON CAPITAL STOCK SUBSCRIBED 



Oct. 15 To record the 
subscription to 
200 shares 



$20,000.00 



340 FUNDAMENTALS OF ACCOUNTING 

UNISSUED BONDS, 20 YEARS, 6% 



Oct. 30 To record issue 
of 1,000, 20- 
year, 6% Cou- 
pon, Nov. 15 
and May 15 $100,000.00 



Nov. 15 To record sale 
to Philadelphia 
Investment Co. $100,000.00 



TWENTY- YEAR, 6% FIRST MORTGAGE BONDS 



Oct. 30 To record the 
issue of i ,000 
bonds par $100, 
20-year Cou- 
pon, 6% May & 
Nov. 15 



$100,000.00 



BOND DISCOUNT 



Nov. 15 



L.OOO.OO 



CASH ADVERTISING FUND 



Nov. 1 8 For sale of do- 
nated preferred 
stock 



9,800.00 



THE E. M. CORPORATION TRIAL BALANCE 

Unissued Common Capital Stock $ 96,800.00 

Authorized Common Capital Stock .... $200,000.00 

Unissued C. S. 6% Preferred 150,000.00 

Authorized C. S. 6% Preferred 200,000.00 

Cash 176,142.00 

Organization Expense 2,700.00 

Accounts Receivable 19,824.00 

Inventory of Furniture 24,200.00 

Inventory of Supplies 3,640.00 

Delivery Equipment 720.00 

Fire Insurance Unexpired 80.00 

Notes Payable 8,000.00 

Accounts Payable 12,106.00 

Patent Rights 50,000.00 

Treasury Stock Preferred 10,000.00 

Surplus for Advertising 19,800.00 

Subscriptions Contracts Receivable . . . 12,000.00 

Common C. S. Subscribed 20,000.00 

Twenty-year 6% First Mortgage Bonds 100,000.00 

Bond Discount 4,000.00 

Cash Advertising Fund 9,800.00 

$559,906.00 $559,906.00 



THEORY OF CORPORATIONS APPLIED 341 

The trial balance above was taken to prove the general ledger 
in balance and to serve as a basis for the preparation of a bal- 
ance sheet which is exhibited on the following page. 

The student may have noticed that no routine business trans- 
actions were included in the problem. Purchases and sales of 
merchandise and other usual transactions of a going concern 
were purposely omitted. The problem may therefore seem to 
lack practicality, but no apologies are offered because, as was 
said before, our principal purpose is merely to illustrate in an 
example some of the transactions peculiar to the corporation. 

E. AND M. BALANCE SHEET AS OF NOVEMBER 18, IQ 

ASSETS 
Current Assets: 

Cash General Fund $176,142.00 

Cash Advertising Fund 9,800.00 

Treasury Stock Preferred 10,000.00 

Subscriptions Contracts Receivable . 12,000.00 

Accounts Receivable 19,824.00 

Total Current Assets - $227,766.00 

Fixed Assets: 

Inventory of Furniture 24,200.00 

Inventory of Supplies 3,640.00 

Delivery Equipment 720.00 

Patent Rights 50,000.00 

Total Fixed Assets 78,560.00 

Deferred Charges: 

Insurance Unexpired 80.00 

Bond Discount 4,000.00 

Organization Expense 2,700.00 

Total Deferred Charges 6,780.00 

Total Assets $313,106.00 

LIABILITIES AND CAPITAL 

Liabilities 

Current Liabilities: 

Notes Payable $ 8,000.00 

Accounts Payable 12,106.00 

Common C. S. Subscribed 20,000.00 

Total Current Liabilities $ 40,106.00 

Fixed Liabilities: 

20-year 6% First Mortgage Bonds . . 100,000.00 

Total Liabilities $140,106.00 



342 FUNDAMENTALS OF ACCOUNTING 

Net Worth 

Common Stock: 
Authorized $200,000.00 
Less Un- 
issued . . 96,800.00 
Issued and Out- 
standing 103,200,00 

6% Preferred Stock: 
Authorized 200,000.00 
Less Un- 
issued . . 150,000.00 

Issued and Out- 
standing 50,000.00 

Total Capital Stock Outstand- 
ing $153,200.00 

Surplus for Advertising 19,800.00 

Total Capital and Surplus . . $173,000.00 

Total Liabilities and Net 

Worth $313,106.00 



PROBLEM MATERIAL 

PROBLEM i 

Mr. E. Johnson, L. Lamont, and C. Davis, who are graduate phar- 
macists, own and operate three independent drug stores in Newark, 
N. J. They decide to organize a Corporation to be known as the 
Consolidated Drug Stores Inc. which shall have as its principal pur- 
pose the immediate taking over and operation of the three inde- 
pendent stores, and to gradually build up a chain; also to manufac- 
ture certain staple and patent medicines. They seek the advice and 
counsel of Mr. H. Thomas, an attorney, who files an application for 
a charter with the State of New Jersey, requesting the right to issue 
$1,000,000 worth of Common Capital Stock and $1,000,000 worth 
of 6% preferred Capital Stock, all shares having a par value of 
$100.00. The three original incorporators each subscribe to twenty 
shares of common capital stock, certified checks to be paid the corpo- 
ration as soon as the Charter is received. 
November i. 

An approved charter in the name of " Consolidated Drug Stores 
Inc." is received from the State of New Jersey approving the issuance 
of stock as requested. Messrs. Johnson, Lamont and Davis pay in 
their checks and take their stock certificates each for twenty shares. 
With the aid of Attorney Thomas they organize the corporation, each 



THEORY OF CORPORATIONS APPLIED 343 



of the three stockholders are elected to the Board of Directors and 
Mr. Johnson is voted President and General Manager, Mr. Lamont 
Vice President to be in charge of manufacturing, while Mr. Davis is 
also a Vice President and to act as Treasurer. Mr. Thomas is to act 
as Legal Adviser of the Corporation. Mr. Thomas advanced all fees 
and costs in obtaining the charter and by proper resolution his bill 
for $1,500.00 is approved for immediate payment, he is to receive 
$500.00 in cash and ten shares of the preferred stock. 
November 2. 

The Board of Directors by proper resolution approve the following 
Balance Sheets and agree to purchase each of the three drug stores 
to be the original units of the contemplated chain. Each Proprietor 
agrees to accept shares of the Common Capital Stock for their equities 
and the assets and liabilities are accordingly taken over and stock 
issued to consummate the agreement approved by the above men- 
tioned resolution of the Board of Directors. 



Balance Sheet as of Nov. i 
Assets 

Inventory 

Fixtures and Equipment 
Land and Buildings .... 

Goodwill 

Total Assets 



Johnson 



Lamont 



Liabilities 

Accounts Payable . . , 

Notes Payable 

Mortgage Payable . . . 
Total Liabilities . . , 



$ 8,000.00 $ 7,500.00 

12,000.00 10,000.00 
15,000.00 

10,000.00 _ 10,000,00 

45,000.00 27,500.00 

$ 2,500.00 $ 2,500.00 
2,000.00 

7,500.00 



Davis 

$ 6,000.00 
8,000.00 

10,000.00 



12,000.00 



2,500.00 



Net Worth 
Capital Accounts 

Total Liabilities and Net Worth 



33,000.00 25,000.00 
$45,000.00 $27,500.00 



24,000.00 

$ 3,000.00 
1,000.00 

4,000.00 

20,000.00 
$24,000.00 



November 5. 

Mr. Johnson, Mr. Lamont and Mr. Davis each donate back to the 
Corporation 100 shares of Common Capital Stock to be held in the 
treasury, and when sold the proceeds are to be used for the purchase 
of a manufacturing chemist's business. 
November 7. 

The 300 donated shares are sold to Mr. A. Wilson for $24,000.00 
cash. 
November 10. 

The Corporation by proper resolution of the Board of Directors 
authorizes the officers to purchase the going business of the " United 
Chemists," a partnership owned and operated under this registered 
trade name by Mr. J. Hughes and Mr. C. Ray, as indicated by the 
certified Balance Sheet below. The Corporation is to take over all 



344 FUNDAMENTALS OF ACCOUNTING 

Assets at their book value and to assume the Mortgage. Mr. Hughes 
and Mr. Ray each agree to accept payment one fourth in cash and 
the balance in preferred shares of capital stock of the Corporation. 

UNITED CHEMISTS 
Balance Sheet as of Nov. 10, 194- 

Assets Liabilities 

Land and Buildings . . $42,000.00 Mortgage Payable . . . $25,000.00 

Laboratory Equipment 20,000.00 

Inventory 16,000.00 

Delivery Equipment . 2,000.00 N e * Worth: 

Trade Name and Good- J. Hughes 40,000.00 

Will 5,000.00 C. Ray 20,000.00 

$85,000x10' $85,000.00 

November 15. 

The Corporation by proper resolution of the Board of Directors 
propose to purchase a five acre site adjoining the United Chemists 
to be used for the erection of a new building. The price is $15,000.00 
and payable $10,000.00 in cash and $5,000.00 in the Corporation's 
preferred stock. The General Realty Co. accept the offer and the 
transfer is completed. 
November 18. 

The officers of the Corporation have agreed to offer an issue of 4% 
bonds, the proceeds of which are to be used to build and equip a new 
manufacturing plant and laboratory. The Board of Directors there- 
fore by proper resolution authorize an issue of 200 one thousand 
dollar thirty year 4% bonds with coupons payable November 30 and 
May 30 of each year. The Maxwell Finance Co. agree to purchase 
the entire issue for $194,000.00. The bonds are to be printed and 
delivered by November 25. 
November 24. 

The bonds are received from the American Bank Note Company 
with a bill for $200.00 for printing and engraving the bonds. The 
bill is paid by check. 
November 25. 

The bonds are turned over to the Maxwell Finance Co. and their 
certified check for $194,000.00 is received. 
November 27. 

A bill for $150.00 from Mr. Thomas for legal services in approving 
the bond issue is paid in cash. 
December i. 

Mr. T. Howard, a stock salesman, is engaged to solicit subscrip- 
tions for the Corporation's preferred stock, from a selected list of 
friends of the officers of the Corporation. The subscriptions are 
to be at par payable one third on or before Jan. i when the stock 
is to be issued, the balance in two equal installments Feb. i and 
.March i. 



THEORY OF CORPORATIONS APPLIED 345 

December 75. 

Mr. Howard has completed his canvass and submits the following 
subscriptions list: 

J, Long 10 shares check for $ 333.34 

T. Barrow 15 shares ' " 500.00 

M. Shaw 20 shares ' " 666.67 

L. Lewis 30 shares ' " 1,000.00 

W. Newton 25 shares ' " 833.34 

T. Powers 60 shares ' " 2,000.00 

The Board of Directors agree to discontinue the canvass for sub- 
scriptions and pay Mr. Howard $480.00 for his services. 

Required: 

1. Write journal entries to give expression to all the above transac- 
tions and happenings. Use the date and a brief explanation with 
each entry. 

2. Open Ledger accounts and post all the journal entries. 

3. Take a Trial Balance. 

4. Prepare a Balance Sheet. 



CHAPTER XIX 

DEPARTMENTAL ACCOUNTING AND COLUMNAR 

JOURNALS 

WHY A DEPARTMENTALIZED BUSINESS 

Department stores, of course, recognize the value of depart- 
mental records and reports. They have been keeping their 
records by departments for years. Their accounting set-up is 
the last word in accounting efficiency. It is not the purpose of 
this chapter, however, even to try to explain the operation of a 
modern set of books and records as maintained by a large de- 
partment store, but rather to point out some of the advantages 
of departmental accounting and show how this type of account- 
ing might be used to advantage by a moderate-sized business 
and even by a small business. 

Many businesses are operated as single enterprises, so far as 
their accounting records are concerned, when their business is, 
in fact, being operated on a departmental basis. 

A good example might be the modern drug store. Some stores 
have already been introduced to the value of departmental 
records and know their income and expenses by departments. 
They have divided their business into departments such as 
(i) Prescriptions, (2) Patent Medicines, (3) Perfumes and 
Cosmetics, (4) General Merchandise, (5) Soda Fountain, 
(6) Cigars, Cigarettes, and Candies, (7) Lending Library. 
They know the gross profits by departments and know their 
most profitable and their least profitable departments. Others 
continue to operate, so far as records are concerned, more or 
less as a single-unit business with no breakdown of sales or 
gross profits by departments. These stores know the net re- 
sult of their operations, a gain or a loss, but as to the relative 
value of the several departments, they have nothing factual to 
guide them. 

Another such group of stores are the Furniture stores, which 
might, for example, maintain departments for: ( i ) Living Room 
Furniture, (2) Dining Room Furniture, (3) Bed Room Furni- 
ture, (4) Radios, (5) Washing Machines, (6) Refrigerators, 
and so forth. 

346 



DEPARTMENTAL ACCOUNTING 347 

The so-called super markets are usually divided into at least 
three major departments or divisions: (i) Groceries, (2) Fruits 
and Vegetables, (3) Meats. The dealers in gasoline, oil, tires, 
tubes, and accessories might keep their records by departments. 
All of these groups would probably benefit if their records were 
departmentalized to the extent, at least, that their owners 
would know the relative importance of the several departments. 
If such information were available, the operator would know 
which products or departments should be promoted, expanded, 
and built up, and, at the same time, which departments might 
be curtailed, changed, or possibly eliminated. 

INTRODUCTION TO DEPARTMENTAL RECORDS 

When it has been decided to install a new system of records 
on a departmental basis, one of the first things to be decided 
should be the extent of the breakdown by departments. What- 
ever decision is finally arrived at, the Purchases, Sales, Pur- 
chases Returns, Sales Returns, and Inventory accounts will 
have to be kept separately. No longer will one Purchases ac- 
count or one Sales account be sufficient, but rather one Pur- 
chases account will have to be maintained for each department. 
If a new system were contemplated for a drug store, for example, 
it would be necessary to set up one account for the purchase of 
drugs or chemicals which might be charged to Prescriptions or 
Pharmacy Department Purchases. Purchases of patent medi- 
cines might be charged to Purchases of Patent Medicines ac- 
count. The important point to note is that whatever breakdown 
is decided for purchases, the same classification must be made 
for Sales, Purchases Returns, Sales Returns, and Inventories. 
All of this is necessary so that the accountant may be able to 
determine at least gross profits by departments. 

In this chapter we shall not try to use any particular business 
as a model, but rather try to illustrate some fundamental forms 
which might be used, expanded, or changed to meet the needs 
of a particular business. In this respect we shall simply desig- 
nate the several departments by letter, as A, B, C, and the num- 
ber of departments in most instances will be limited to three, 
realizing that the principles learned from the operation of a 
three-department business would be the same when applied to 
a business requiring many more departments. 



348 



FUNDAMENTALS OF ACCOUNTING 



PURCHASES BY DEPARTMENTS 

Purchases will originate as always through the issuance of a 
purchase order, and the subsequent receipt of an invoice which, 
in turn, will be audited and approved for payment. None of 
the foregoing procedure will be affected in the least by the in- 
stallation of separate departmental purchase accounts. Fre- 
quently, however, one invoice may list materials or merchandise 
which must be charged to two or more departments. When this 
is true, it will be necessary for someone acquainted with the 
classification of accounts to indicate how the separate items 
should be charged. 

DEPARTMENTAL PURCHASE BOOK 

A purchase book, such as the one illustrated, could be used 
very satisfactorily by any business requiring three departments. 
The use and operation of the book, as before mentioned, could 
very easily be expanded to accommodate any number of de- 
partments. The operation of this book, which is to be explained 
immediately, would be fundamentally the same regardless of 
the number of departments involved. 

PURCHASES FOR MONTH OF 3)jM*s*HArts f<?4 



DATE 



ACCOUNT CREDIT 



PURCHASE 
ORDER # 



CREDIT 



ACCTS. 
PAYABLE 



DEBIT 



DEPT. 
A 



DEPT. 
B 



DEPT. 

c 



00 



120 



00 



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ft. 



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00 



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500 



on 



fix 121 



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00 



00 



00 



fiX ID*+ 



7,50 



00 



00 



fiX 1 25 



LL 



m 



MZ 



00 



lb 



BX/lh 



00 



00 



00 



120 



00 



fix 111 



ML 



W 



M 



J20. 



00 



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DEPARTMENTAL ACCOUNTING 349 

The column at the extreme left is the usual date column. The 
next column, headed Account Credit, is provided for the name 
of the account to be credited in the subsidiary accounts pay- 
able ledger. The following space is provided for some brief 
explanation of the purchase; this may be simply the purchase 
order number which refers to the primary document filed for 
convenient reference, or, where vouchers are used in a voucher 
system, simply the voucher number is recorded. The next nar- 
row column is the usual folio column and is provided for the 
page set aside for each account in the Accounts Payable Ledger. 
The continued use of controlling accounts and subsidiary 
ledgers is presumed in this chapter. The first money column is 
provided for the total amount to be credited to the individual 
accounts kept in the Accounts Payable Ledger. Posting from 
this column is usually done from day to day. The next three 
money columns are provided for the analysis of the purchase by 
departments. The amounts written in these three columns are 
to be posted only in total at the end of the accounting period, 
usually each month, to the debit of the three separate purchases 
accounts kept in the General Ledger. In addition to posting 
the three purchases accounts at the end of the month as just 
indicated, it will be necessary to post the total of the Accounts 
Payable Controlling account. This posting to the General 
Ledger controls the separate postings made to the individual 
accounts kept in the subsidiary Accounts Payable Ledger made 
from day to day, as indicated above. 

DEPARTMENTAL SALES BOOK 

A sales book such as the one illustrated could be used very 
satisfactorily also by a business organized on a three-depart- 
ment basis; and, as was said with reference to the Purchase 
Book, the form could very easily be expanded to accommodate 
any number of departments. 

The usual date column is provided at the extreme left. The 
next space is provided for the account to be debited. The fol- 
lowing space is provided for some brief explanation of the sale, 
the invoice numbers for the sales made to customers on account 
or the words cash sales will be satisfactory. The folio column 
is used for recording the page set aside for each customer in 
the Accounts Receivable Ledger. The first money column is 



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DEPARTMENTAL ACCOUNTING 351 

provided for the total amount of the invoice to be debited or 
charged against the individual accounts kept in the Accounts 
Receivable Ledger. Posting from this column is usually done 
from day to day. The second money column is a column in 
which are listed all cash sales, and is placed there for the con- 
venience of the bookkeeper, because it helps him segregate the 
cash sales from the sales on account. The column is not posted 
either daily or monthly and for this reason a check mark has 
been placed in the folio column alongside each cash sale and also 
at the end of the cash sales column. The debit to the cash ac- 
count will, of course, be made from the Cash Receipts Book, 
where also the account is checked to prevent double posting to 
the Sales account. The amounts of both types of sales, cash 
sales and sales on account, are, of course, extended to the several 
departments as directed, and as indicated in the illustration. 
The amounts written in these columns are to be posted only in 
total at the end of the month to the credit of the three separate 
sales accounts kept in the General Ledger. In addition to post- 
ing the three sales accounts at the end of the period, as just indi- 
cated, it will be necessary to post the total of the Accounts 
Receivable column to the debit of the Accounts Receivable Con- 
trolling account. This posting to the General Ledger controls 
the separate postings made to the individual accounts kept in 
the subsidiary Accounts Receivable Ledger, as explained above. 

CASH RECEIPTS BOOK 

A cash receipts book designed for a departmental business 
will need no modification or expansion because the business is 
being operated on a departmental basis, but rather any good 
standard cash receipts journal should work satisfactorily. The 
form illustrated has been expanded slightly to make its use a 
little more convenient. The date column, the space for the ac- 
count to be credited, and the explanation column need no intro- 
duction to the student, and their functions remain the same as 
always. The money columns, however, might be studied for a 
better understanding of their fullest use; with this purpose in 
mind, therefore, let us review the functions of each. 

The first column, headed Accounts Receivable, is provided 
for credits to customers for the total of the account paid by their 
remittance in accordance with the credit terms. In our ex- 



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DEPARTMENTAL ACCOUNTING 353 

ample, on December 9, a check was received from T. French for 
$637.00 to pay an account of $650.00 less a 2 % discount; there- 
fore, in the Accounts Receivable column Mr. French is credited 
with the $650.00, even though the net remittance is only 
$637.00. This is true also with all other customers' accounts; 
they are credited in the Accounts Receivable Ledger column 
with the full amount of their accounts, the sales discount ex- 
pense being charged for the difference between the remittance 
and the face of the account settled in accordance with the credit 
terms. The total of this column should be posted to the credit 
of the Accounts Receivable Controlling account in the General 
Ledger and will control the individual credits made in the sub- 
sidiary Accounts Receivable Ledger. 

The second money column is provided for cash received from 
sundry sources for which no special column is provided. The 
amounts entered in this column are posted directly to the Gen- 
eral Ledger to the credit of the Accounts responsible for the 
cash received, as, for example: On December 2 the proprietor, 
Mr. Elder, made an additional cash investment of $1500.00. 
This amount is credited directly to his capital account in the 
General Ledger. In the same manner, on December 3, when 
the proprietor discounted his note at the bank, the Notes Pay- 
able account was credited directly in the General Ledger for 
$2000.00, the face of the note payable. Because the individual 
credits from this column have been made directly to the General 
Ledger, the total must not be posted and is therefore checked. 

The third money column lists all cash received from cash 
sales, and is provided so that cash received from all sources may 
be included in the Cash Receipts Book. The credit to Sales 
for all sales including cash sales having been made through the 
Sales Book, the individual credits to sales, as well as the total 
of the column, must not be posted from this book. A check 
mark placed in the folio column alongside each sale and below 
the total of the column will help prevent double posting. 

The Sales Discount column is simply a convenience column 
to record all discounts allowed customers and deducted from 
their remittances in accordance with the credit terms. The col- 
umn is posted in total only at the end of the period to the debit 
of the Sales Discount account in the General Ledger. The next 
column has been provided for Interest Expense deductions made 



354 FUNDAMENTALS OF ACCOUNTING 

when notes are discounted. The introduction of this conven- 
ience column to the Cash Receipts Book makes split entries 
unnecessary. That is, formerly the interest expense had to be 
put through the General Journal leaving only the net cash re- 
ceived to be entered in the Cash Receipts Book. Such a split 
entry utilizing two journals has therefore been simplified, and 
the entire transaction can now be accommodated in the Cash 
Receipts Book. Furthermore, the column need be posted only 
in total, as indicated in the illustration. The final or Net Cash 
Received column operates as always. It is posted in total only 
once at the end of the period to the debit of the Cash account 
in the General Ledger. 



CASH DISBURSEMENTS BOOK 

A cash disbursements book designed for a departmental busi- 
ness need not be modified or expanded in any way because the 
business is operated on a departmental basis ; but, as with the 
Cash Receipts Book, any good standard cash disbursements 
form should prove satisfactory. The form illustrated has been 
expanded slightly to make its use a little more convenient. The 
date column, the space for the account to be debited, and the 
explanation space need no introduction to the student, and 
their functions remain the same. 

The money columns, however, might be studied for a better 
understanding of their fullest use; therefore, with this purpose 
in mind let us review the functions of each column. 

The first money column, headed Accounts Payable Ledger, is 
provided for the debits to Accounts Payable accounts for the 
total of the account being paid by our check in accordance with 
the credit terms. In our example, on December 8 a check is 
sent to Mr. T. Walsh for $705.60 to pay our account in amount 
of $720.00 less a 2% discount; therefore in the Accounts Pay- 
able column, Mr. Walsh is debited with $720.00. even though 
the net remittance is only $705.60. This is true also with all 
other creditors 7 accounts: they are debited in the Accounts 
Payable Ledger column with the full amount of their account, 
the purchase discount being credited with the difference be- 
tween the remittance and the face of the account settled in ac- 
cordance with the credit terms. The total of this column should 



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356 FUNDAMENTALS OF ACCOUNTING 

be posted to the debit of the Accounts Payable Controlling ac- 
count in the General Ledger. 

The second money column is provided for disbursements to 
miscellaneous General Ledger accounts. The items in this col- 
umn are posted daily to the accounts in the General Ledger, 
and the total of the column is checked to prevent double posting. 

The third money column, headed Salaries and Wages, is a 
convenience column in which are listed all payments made for 
salary and wages. The column is posted in total only at the 
end of the month. The Interest Expense column likewise has 
been added simply for the convenience of the bookkeeper. The 
total of this column is also posted only in total at the end of the 
month. The Purchase Discount column and the Net Cash col- 
umn need no explanation here because they are posted as ex- 
plained before in our first treatment of special journals. 

THE GENERAL JOURNAL 

The six-column General Journal form, as used in the first 
chapter treating with controlling accounts, will serve very well 
in any business including, of course, a departmental one. It 
will not be necessary nor desirable at present to illustrate or 
explain the form further. For review the student may refer to 
the earlier chapter on Controlling Accounts. 

NOTES RECEIVABLE BOOK 

A notes receivable book will prove a valuable addition to any 
accounting system if the business receives more than a few 
notes. In such a case a Notes Receivable Register similar to the 
one illustrated herewith should prove satisfactory in most cases. 

The operation of this journal may be apparent from observa- 
tion of the form; however, a brief explanation of the several 
columns may be helpful to the beginning student. 
, At the extreme left are two date columns; the first is pro- 
vided for the date the note was received, while the second col- 
umn is for the date of the instrument. The next space is 
provided for the name of the account to be credited. Then fol- 
lows the usual ledger folio column. The face of the note is next 
listed, after which is provided space for the maker or drawer's 
name (maker for notes, drawer for trade acceptances or drafts), 



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358 FUNDAMENTALS OF ACCOUNTING 

followed by a space in which indorsers' names, if any, should be 
registered. At the end of the month the amount column is 
added and the total is debited to the Notes Receivable account 
in the General Ledger; the credit should be posted in total to the 
Accounts Receivable Controlling account in the General Ledger. 
Each day, as the notes are received and entered in the register, 
the individual accounts are credited in the Accounts Receivable 
Ledger. 

The form illustrated will be very helpful in managing notes 
receivable; for instance, the maturity date is very easily ob- 
served. Most cashiers or treasurers send out notices from a 
week to ten days prior to maturity, then, as notes mature, their 
disposition is registered. If a note is paid in full, as we expect, 
that fact is noted and a cash receipts book reference may be 
indicated for cross reference. If the note is renewed in whole 
or part, then that fact is likewise recorded. 

If a company receives a great many notes, an alternative 
method for recording notes in this same form may be put into 
operation. In such a case, one or more pages of the register are 
provided for each of the twelve months of the year. As each 
note is received, it is entered on the page of the month the note 
matures. Thus notes received during April would be recorded 
in the month of their maturity. At the end of each month the 
notes received in that month are summarized and the totals 
posted as before. The advantages of this alternative use is that 
all maturities are grouped together by months and their col- 
lection and other handling is somewhat facilitated. 

If notes are received in great volume and the notes are pay- 
able in a series of equal installments, as with a finance company, 
then such a register as illustrated would not be satisfactory. In 
this instance the note is merely considered collateral for an ac- 
count which is opened to each customer. A notes receivable 
controlling account is kept in the General Ledger and cards are 
opened for each account. As payments are received, they are 
recorded in a special Cash Receipts Book, from which they 
are credited to the individual cards or account books, as they 
are sometimes called. The total cash receipts from notes is 
posted from the total of the special column in the Cash Receipts 
Book to the Notes Receivable account in the General Ledger. 
The balance of the control account should, of course, agree with 



DEPARTMENTAL ACCOUNTING 359 

the total due from all notes outstanding as listed from the cus- 
tomers' book or cards. 



SALES RETURNS JOURNAL 

This book will be used when the number of returns warrant 
it. That is, if there are relatively few returns, then a special 
journal for returns is not warranted, and returns will be re- 
corded as usual through the General Journal. On the other 
hand, just as soon as the number of returns grows to a sizable 
figure, the use of a special journal will become apparent. When 
separate Purchase and Sales accounts are being operated for 
each department, then separate Sales Returns accounts must 
be maintained. This is necessary so that we may prepare de- 
partmental profit and loss statements. No illustration of a 
Sales Returns Book need be given at this time, but a brief ex- 
planation of the function and the use of such a form may be 
appropriate. The form, beside the usual date column, would 
provide space for the account to be credited for the return, and 
then a total column might be provided as well as separate col- 
umns by departments. The operation of the book would be 
quite similar to the operation of the Sales Book, except, of 
course, that the postings would be credits to the customers and 
debits to the Sales Returns account. 

OTHER SPECIAL JOURNALS 

There are several other special journals which might be used in 
individual businesses as the case warranted. The guiding prin- 
ciple is to open a special journal to record any group of similar 
accounts or facts if the volume of such similar transactions war- 
rants a special journal. It is one of the duties of the practicing 
accountant, the controller, or one of his assistants to design these 
special journals as their need becomes apparent. Consider, for 
instance, a company which holds considerable real estate. Such 
a company might be able to use a Mortgage Register, a book 
similar to, but more elaborate than, the Notes Receivable Regis- 
ter illustrated in this chapter. The same company would proba- 
bly also require an Insurance Register. This book would record 
all insurance policies held and would make it possible for the 
management to note easily the adequacy of insurance coverage. 



360 FUNDAMENTALS OF ACCOUNTING 



DEPARTMENTAL PROFIT AND LOSS STATEMENTS 

Probably the most important reason for operation of depart- 
mental books is that such records may be available for the 
preparation of income profit and loss statements by depart- 
ments. Such statements will make it possible for the manage- 
ment to determine the relative value of departments or products, 
as a study of the statements which follow will make apparent. 

DEPARTMENTAL PROFIT AND LOSS STATEMENTS 
ILLUSTRATED 

In order to visualize best the use and operation of the profit 
and loss statement by departments, an after-adjustment trial 
balance is presented, from which the departmental profit and 
loss statement was prepared. 

THE RoGERS-HiLLARD COMPANY, INC. 
Adjusted Trial Balance as of December 3 1 , 



Cash $ 22,415.00 

Accounts Receivable 33,810.00 

Notes Receivable 6,000.00 

Reserve for Doubtful Accounts $ 642.00 

Inventory Dept. A. Jan. i, 19 12,120.00 

Inventory Dept. B. Jan. i, 19 8,492.00 

Inventory Dept. C. Jan. i, 19 9,250.00 

Land 2,000.00 

Buildings & Equipment 36,000.00 

Reserve for Dep. of Bldgs. & Equip. . . 3,960.00 

Selling Expense Dept. A 8,096.00 

Selling Expense Dept. B 6,072.00 

Selling Expense Dept. C 5,816.00 

General & Ad. Exp. Dept. A 6,500.00 

General & Ad. Exp. Dept. B 4,060.00 

General & Ad. Exp. Dept. C 4,225.00 

Interest Expense 118.00 

Interest Income 172.00 

Purchase Discounts 196.00 

Sales Discounts 244.00 

Sales Dept. A 81,960.00 

Sales Dept. B 65,840.00 

Sales Dept. C 64,810.00 

Return Sales & Allow. Dept. A 1,246.00 

Return Sales & Allow. Dept. B 820.00 



DEPARTMENTAL ACCOUNTING 



361 



Return Sales & Allow. Dept. C $ 915.00 

Prepaid Advertising 120.00 

Prepaid Insurance 215.00 

Accounts Payable $ 28,740.00 

Mortgage Payable 18,000.00 

Purchases Dept. A 61,590.00 

Purchases Dept. B 47,343.00 

Purchases Dept. C 44,767.00 

Return Purchases Dept. A 840.00 

Return Purchases Dept. B 618.00 

Return Purchases Dept. C 582.00 

Capital Stock Authorized 100,000.00 

Unissued Capital Stock 60,000.00 

Surplus 15,874.00 

Inventory Dept. A. Dec. 31, 19 .... 11,400.00 
Inventory Dept. B. Dec. 31, 19 .... 7,205.00 
Inventory Dept. C. Dec. 31, 19 .... 8,462.00 
Profit & Loss Summary (new inven- 
tories) ^12j?^li 2. 

$409,3^1 .00 $409,301 .00 



The trial balance has been made complete, in so far as ac- 
counts required for our immediate use are concerned, but other- 
wise in order to conserve space the number of other accounts 
has been kept to the minimum. The current expense for doubt- 
ful accounts, several depreciation expense accounts, advertising, 
delivery expense, and all other miscellaneous selling, general, 
and administrative expenses have been transferred to Selling 
Expense and General and Administrative Expense accounts by 
departments. 

The illustration shown herewith was prepared from the fore- 
going adjusted trial balance. 

A study of the statement above will yield many interesting 
facts, and from which many helpful observations may be made. 
One or two such general observations are given, but only to 
illustrate the use which may be made of such statements. Fur- 
ther facts and an intimate acquaintance with a particular case 
would make the observations more accurate and more helpful. 

A first and general observation might be with regard to the 
relative profitableness of the three departments. In Depart- 
ment C for example, although the sales are less than B and 
much less than A, it is nevertheless the most profitable. Its net 
operating profit is $8881.00, based on $64,810.00 of sales a 



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DEPARTMENTAL ACCOUNTING 363 

percentage gain of 13.6%, while Department B operated at a 
gain of 10.4% and Department A was profitable to the extent 
of only 5.7%. 

Based on these facts, it should be apparent that if possible 
Department C should be developed, while the activities of De- 
partment A might well be curtailed. This is, of course, a very 
general observation, for, while it might be very well to build up 
and develop Department C, it is just possible that Department A 
may be indispensable to the organization and must be con- 
tinued. A good illustration taken from an actual case was that 
of a large drug store which operated many departments. The 
management found that its Soda Fountain, which we shall call 
Department C, was very profitable, and, of course, the com- 
pany did all possible to build up this department. The best 
space was .given to the fountain, its size was expanded at the 
expense of a lending library which was discontinued because 
it did not pay enough. In this case Department A was the 
Pharmacy and Prescription Compounding Department and was 
vital to the continuation of a drug store; therefore, while it was 
put farther into the back of the store, some of the room gained 
was given to the Cosmetics Department which also was more 
profitable and could not be discontinued. 

A further study of the departmental expenses selling and 
the general and administrative expenses might yield some 
very interesting facts, but we shall not go further into this ab- 
sorbing work of interpretive accounting at this time. 



QUESTIONS ON THE CHAPTER 

1. What is the real value of departmentalized records? 

2. Mention several departments you might designate if you were 
preparing a new accounting system for a large modern retail drug 
store. 

3. Outline the departments you would install for a retail hard- 
ware store under the same circumstances. 

4. Assume you are engaged to install a system of records for a 
newly formed Super Market, which will operate separate departments 
for: i. Groceries, 2. Meats, 3. Fruits and Vegetables, 4. Dairy 
Products. Based on these facts draft a Purchase Book, and explain 
its use and operation in the system. 

5. For the same business and based on the same facts draft a Sales 
Book, and explain its use and operation in the system. 



364 FUNDAMENTALS OF ACCOUNTING 

6. Assume the same engagement as above, and further that all 
sales are for cash. Based on these facts design a good Cash Receipts 
Book. 

7. Assume the same facts as before for the same Super Market, 
and further that the company plans to use a subsidiary Accounts 
Payable Ledger. Draft a good Cash Disbursements Book, include 
in addition to all usual columns convenience columns for " Interest 
Expense/' and " Advertising." 

8. Would the General Journal have to be especially designed for 
the Super Market? Explain why or why not. 

9. Draft a Profit and Loss Statement which might be prepared 
from the system of books you have just designed. You supply illus- 
trative figures, and explain its operation as far as gross profits by de- 
partments are obtained. 

10. What are some of the conclusions one might get from a study 
of such a departmentalized statement? 



PROBLEM MATERIAL 

PROBLEM i 

November i. 

T. Wentworth starts business with a cash investment of $5000.00. 
He specializes in the wholesale distribution of shoes, hosiery, and 
sundries. He uses a departmental system of accounts in his busi- 
ness. The books will be kept on a departmental basis, Depart- 
ment A Shoes; Department B Hosiery; Department C 
Sundries. Rent to the amount of $300.00 was paid for one 
month. Office Equipment was bought from the United Office 
Supply Co. to the amount of $450.00, on account terms 2/10, 
n/30. 
November 2. 

Purchased a typewriter from the Remington Co., $125.00 Cash. 
November j. 

Purchased $2500.00 of shoes from the Freeman Shoe Co. on account 
terms 2/10, n/3O. Purchased from the Benson Bros, hosiery, 
$250.00 and shoes, $100.00 terms 2/10, 11/30. 
November 4. 

Purchased $2200.00 of shoes, $1200.00 of hosiery, and $1300.00 
of sundries from the General Supply Co. on account terms 
2/10, 11/30. 
November 5. 

Sold $250.00 of shoes, $100.00 of hosiery, and $50.00 of sundries 

to Dodson and Sons, on account terms 2/10, 11/30. 
November 6. 

Purchased $1450.00 of hosiery from the Johnson Hosiery Co. on 
account terms 2/10, 11/30. 



DEPARTMENTAL ACCOUNTING 365 

November 8. 

Sold to Jones Bros. Inc. on account, $500.00 worth of shoes, 
$200.00 worth of hosiery, and $80.00 worth of sundries terms 
2/io, n/3o. Bought from Meeker Co. $750.00 worth of hosiery 
and $300.00 worth of sundries terms 2/10, n/30. 
November g. 

Sent check for $441.00 to the United Office Supply Co. in full pay- 
ment of account. Cash Sales to date were: shoes, $300 .00, 
hosiery, $450.00, and sundries, $356.00. 
November 10. 

Received a check from Dodson and Sons in full payment of invoice 

of November 5th. 
November //. 

Holiday. 
November 12. 

Paid General Supply Co. invoice of November 4. Purchased 
$950.00 worth of shoes from the Freeman Shoe Co., on account 
terms 2/10, n/30. Sold to Barton's Dept. Store, on account, 
$700.00 worth of shoes, $400.00 worth of hosiery, and $257.00 
worth of sundries terms 2/10, n/3O. 
November 13. 

Sold to Cannon Shoe Co. $650.00 worth of shoes on account 
terms 2/10, 11/30. Paid Johnson Hosiery Co. invoice of No- 
vember 6. 
November 15. 

Paid salaries to date $250.00. Purchased from Johnson Hosiery 
Co. hosiery to the amount of $790.00, terms 2/10, 11/30. Re- 
ceived from Jones Bros. Inc. a check in full payment of invoice 
of November 8. 
November 16. 

Paid Meeker Co. invoice of November 8. Cash Sales to date: 
shoes $783.00, hosiery $1432.00, sundries $359.00. Sold to 
Jones Bros. Inc. on account, $400.00 worth of shoes, and $70.00 
worth of sundries terms 2/10, 11/30. 
November 17. 

Purchased from Meeker Co. to the amount of $80.00 in shoes, 

$53,00 in hosiery, and $40.00 in sundries terms 2/10, 11/30. 
November 18. 

Purchased from the General Supply Co. to the amount of $400.00 
in shoes, $30.00 in hosiery, and $1030.00 in sundries terms 
2/10, n/30. 
November IQ. 

Barton's Dept. Store sent us a check for $357.00 and a 6o-day note 
for $1000.00 in payment of invoice of November 12. The Can- 
non Shoe Co. sent us a check for invoice of November 13 less 
discount. 
November 20. 

Unsatisfactory shoes were returned to the General Supply Co. for 



366 FUNDAMENTALS OF ACCOUNTING 

which we received a credit memo of $150.00. Paid Johnson 
Hosiery Co. invoice of November 15. Jones Bros., Inc., sent us 
a check in payment of invoice of November 16. 

November 22. 

Purchased $2800.00 worth of shoes from the Freeman Shoe Co. on 
account terms 2/10, 11/30. Sold to Cannon Shoe Co., shoes 
to the amount of $875.00 on account terms 2/10, n/3o. 

November 23. 

Cash Sales to date amount to $954.00 of shoes, $800.00 of hosiery, 
and $300.00 of sundries. 

November 24. 

Sales on account to Barton's Dept. Store amounted to $200.00 of 
shoes, $240.00 of hosiery, and $140.00 of sundries, terms 2/10, 
n/3o. Received a check from Cannon Shoe Co. in full payment 
of invoice of November 22. Cost of window cleaning to date 
was $5.00 gave check for amount. 

November 25. 

Sold to Doclson and Sons on account, shoes, $250.00, hosiery, 
$400.00, and sundries, $350.00 terms 2/10, n/3O. Sent check 
to Meeker Co. in payment of invoice of November 17. 

November 26. 

Purchased from Meeker Co. on account, shoes, $500.00, hosiery, 
$350.00, and sundries, $50.00 terms 2/10, n/3O. Barton's 
Dept. Store returned $145.00 worth of unsatisfactory hosiery 
for which we gave them credit. Mr. Wentworth invested an ad- 
ditional $1000.00. 

November 27. 

Paid salaries to date $250.00. Bought from the General Supply 
Co., on account, shoes, $300.00, hosiery, $257.00, and sundries, 
$50.00, terms 2/10, 11/30. 

November 29. 

Paid General Supply Co. invoice of November 18, discount al- 
lowed, less credit memo. Sold to Cannon Shoe Co. on account, 
shoes, $750.00 terms 2/10, n/30. Received a check from 
Dodson and Sons in payment of invoice of November 25. 

November 30. 

Cash Sales to date: shoes, $424.00, hosiery, $350.00, sundries, 
$356.00. 

Required: Using columnar paper, head the books of original entry as 
follows: 

(1) A Cash Disbursements Book with columns headed: Account 
Debit, Folio, General Ledger Debit, Wages and Salaries, Ac- 
counts Payable, Purchase Discounts, and Net Cash. 

(2) A Cash Receipts Book with columns headed: Account Credit, 
Folio, General Ledger, Cash Sales, Accounts Receivable, Sales 
Discounts, Net Cash. 

(3) A Sales Book with 7 columns: Sales on Account with one col- 



DEPARTMENTAL ACCOUNTING 



367 



iimn for each department, Sales for Cash with one column for 
each department, and Total Sales. 

(4) A Purchase Book with 4 columns: Purchases on Account with 
one column for each department, and a final column for Total 
Purchases. 

(5) A standard six-column General Journal. 

With these books of original entry enter the foregoing transactions 
and total all books for posting. 

Post these books to the General Ledger and subsidiary Accounts 
Receivable and Accounts Payable Ledger. 

Take a trial balance of the General Ledger after the subsidiary 
ledger balances have been checked with their controlling accounts. 

PROBLEM 2 

October 15. 

The American Drug Co., Inc., was chartered this day under the 
laws of the State of New Jersey, as distributors to the wholesale 
drug trade. It was authorized to issue 1000 shares of common 
capital stock with a par value of $100.00 per share. The original 
subscribers to the application for the charter pay in the follow- 
ing sums, and stock certificates are issued as indicated below: 

20 shares to Mr. G. Edwards $2000.00 

20 shares to Mr. H. Thompson $2000.00 

10 shares to Mr. S. Miller $1000.00 

The corporation is organized with Mr. Edwards as the President, 
Mr. Thompson as the Treasurer, and Mr. Miller as the Secretary. 
The corporation agrees to take over the partnership business 
formerly conducted by Messrs. Edwards, Thompson, and Miller, 
issuing capital shares at par value to the partners for their 
equities. The Board of Directors accepts the following balance 
sheet as the basis of the agreement: 



E. T. M. PARTNERSHIP 
Balance sheet as of October 15, 19 



Assets 




Cash 


$ 4,200. 


Accounts Receivable 


6,300. 


Raw Drugs 


3,000. 


Patent Medicines 


4,500. 


Specialty Goods 


4,800. 


Laboratory Equip. 


4,000. 


Land and Buildings 


10,000. 


Good-will 


3,000. 


Total Assets 


$39,800. 



Liabilities 

Notes Payable $ 2,000. 

Accounts Payable 3,800. 
Mortgage Payable 7,000. 
Total Liabilities 



$12,800. 



Net Worth 

Edwards, capital $12,000. 
Thompson, capital 8,000. 
Miller, capital 7,000. 

Total Net Worth ~" 2^000. 

Total Liabilities & Net Worth $397800! 



368 FUNDAMENTALS OF ACCOUNTING 

The Accounts Receivable account balances were as follows: 

Lincoln Drug Supply Co $1360.00 

Metropolitan Drug Stores Inc 1420.00 

Sanitary Products Co., Inc 1320.00 

Thomas Drug Supply Co 1425.00 

Simpson Drug Co 775.00 

$6300.00 

The Accounts Payable account balances were as follows: 

Allied Chemical Co., Inc $2000.00 

Premier Drug Mfg. Co 1800.00 

^3800.00 

New books are to be opened as follows: A four-column General 
Journal with headings: Accounts Payable Debit, General Ledger 
Debit, General Ledger Credit, and Accounts Receivable Credit; an 
Accounts Receivable Ledger and an Accounts Payable Ledger; a 
Cash Receipts Book with money columns headed: General Ledger, 
Accounts Receivable, Sales Discounts, Interest Expense, and Net 
Cash Received; a Cash Disbursements Book with money columns 
headed: General Ledger, Accounts Payable, Purchase Discounts, In- 
terest Expense, and Net Cash Paid. Purchase and Sales Books will 
be kept for a three-department business, as follows: Raw Drugs and 
Chemicals Dept. A., Patent Medicines Dept. B., Specialty Goods 
Dept. C. 

Write journal entries to open the new books and post to the three 
ledgers as required, being certain to open control accounts in the Gen- 
eral Ledger and individual accounts in the subsidiary ledgers. With 
the books properly opened, enter the following transactions: 
October 16. 

Paid Organization Expenses as follows: Rea & Rea for accounting 
services, $500.00; J. Long for legal services, $820.00; Newark 
Printing Co., $120.00. A shipment and invoice from the Allied 
Chemical Co. as follows Raw Drugs, $1040.00; Sundry Items, 
$160.00 terms 2/10, n/3O. Purchased from the Premier Drug 
Co., Raw Drugs, $320.00; Patent Medicines, $1060.00; Sundries, 
$820.00 terms 2/10, n/3o. The bank approves a loan and 
discounts at 6% the corporation's 6o-day note for $2000.00, 
crediting the corporation's account with the proceeds. Sold on 
account to the Sanitary Products Co., Raw Drugs, $41.00; Sun- 
dries, $286.00. Note: All sales are made on uniform credit terms 
of 2/10, n/30. 
October 18. 

New Laboratory Equipment was purchased from the New Jersey 
Laboratory Equipment Co. total invoice was $1740.00 to be 
paid as follows: cash $540.00 and finance notes for the balance 
payable $100.00 per month. Sold on account to the Thomas 



DEPARTMENTAL ACCOUNTING 369 

Drug Co., Raw Drugs, $110.00; Patent Medicines, $214.00; 
Sundries, $196.00. Received a check for $1332.80, from the 
Lincoln Drug Supply Co. as full settlement of their balance 
less 2%. 

October 19. 

Sold on account to the Sanitary Products Co., Raw Drugs, $65.00; 
Sundries, $354.00. Issued check in payment of Freight on the 
Laboratory Equipment, $60.00 and $50.00 to the Laboratory 
Equipment Co. representative for installing the new equipment. 
Received a check from the Sanitary Products Co. in amount of 
$1293.60 full settlement of old balance less 2%. Gave a check 
to Premier Drug Co. for $1764.00 payment of old balance less 
2%. Gave check to Allied Chemical Co. for their old balance 
less 2%. Received a check from the Thomas Drug Co., $1396.50, 
payment of old balance less 2%. 

October 20. 

Sold on account to the Lincoln Drug Supply Co., Raw Drugs, 
$317.00,; Patent Medicines, $213.00; Sundries, $316.00. 

October 21. 

Sold on account to the Thomas Drug Supply Co., Raw Drugs, 
$145.00; Patent Medicines, $258.00; Sundries, $215.00. 

October 22. 

Paid salesmen's weekly salaries of $125.00, also General Office 
Salaries of $180.00. Sold on account to the Lincoln Drug Sup- 
ply Co., Raw Drugs, $324.00; Patent Medicines, $246.00; Sun- 
dries, $340.00. 

October 23. 

We received an order from the Metropolitan Drug Stores Inc., Raw 
Drugs, $420.00; Patent Medicines, $432.00; Sundries, $748.00; 
together with a 6o-day 6% note for $2000.00 dated October 23 
and their check for $999.60 as full payment of their old balance 
plus the amount of their current purchase less 2 % on the amount 
subject to cash discount. The $2000.00 note just received is 
discounted at the Local National Bank (discount rate 6%) and 
the bank account is credited with the proceeds. Sold on account 
to Simpson Drug Co., Raw Drugs, $85.00; Patent Medicines, 
$110.00; Sundries, $33.00. 

October 24. 

A shipment and invoice arrived from the Allied Chemical Co., Raw 
Drugs, $1650.00; Sundries, $190.00 terms 2/10, n/3o. Some 
of the raw drugs just received from the Allied Chemical Co., Inc. 
were spoiled in transit and had to be returned for credit, for 
which a debit memo in amount of $160.00 is issued. 

October 25. 

Purchased from the Premier Drug Co., Raw Drugs, $446.00; 
Patent Medicines, $1024.00; Sundries, $930.00 terms 2/10, 
n/3o. Gave a check for $2156.00 to the Premier Drug Co. 
in full payment of invoice of October 16. Received a 6o-day 



370 FUNDAMENTALS OF ACCOUNTING 

non-interest-bearing note date October 2 5 from the Lincoln Drug 
Supply Co. for $846.00 in full payment of invoice of October 20. 
We discount this note at the Local National Bank discount rate 
6% and the bank credits our account with the proceeds. Re- 
ceived a check from the Sanitary Products Co. in full payment of 
invoice of October 16. We give our 6o-day 6 c /o note to the Allied 
Chemical Co. for $1680.00 for the balance due on purchase of 
October 24. 
October 26. 

A shipment arrived from the United Chemical Co., Inc., Raw Drugs, 
$1445.00; Patent Medicines, $155.00. Terms agreed to were 
bill of lading with sight draft attached. We gave the Local Na- 
tional Bank our check for $1600.00 full acceptance of draft and 
receive the bill of lading. Received a check, $759.50, from the 
Simpson Drug Co. for invoice of October 15 less 2%. Sent our 
check to the Allied Chemical Co. for $1176.00 full settlement of 
invoice of October 16. 

October 27. 

Gave a check for $64.00 to the Local News for advertising to date. 

October 28. 

The bank approved our application for a loan and discounted our 
$2000.00 6o-day note, crediting our account with the proceeds 
(discount rate 6%). Received a check from the Sanitary Prod- 
ucts Co. for $410.62 in payment of invoice of October 19 less 
2%. Also received a check from the Thomas Drug Co. for in- 
voice of October 18 less 2%. Purchased from the United Chemi- 
cal Co., Inc., Raw Drugs, $1000.00; Patent Medicines, $400.00; 
our credit rating is approved and terms are 2/10, 11/30. Pur- 
chased from the Allied Chemical Co. terms 2/10, n/3o, Raw 
Drugs, $1700.00; Sundries, $260.00. Sold on account to the Lin- 
coln Drug Supply Co. $117.00 in Raw Drugs; $113.00 in Patent 
Medicines; and $185.00 in Sundry Items. Sold on account to 
Metropolitan Drug Stores Inc., Raw Drugs, $60.00; Patent Med- 
icines, $125.00; Sundry Items, $233.00. 

October 29. 

Drew checks Salesmen's Salaries for $125.00 and General Office 
Salaries for $180.00. Sold on account to the Sanitary Products 
Co., Raw Drugs, $180.00; Sundry Items, $234.00. 

October 30. 

We received an order from the Simpson Drug Co. for which we bill 
them, Raw Drugs, $110.00; Patent Medicines, $156.00; Sun- 
dries, $46.00. They also claim $24.00 for Patent Medicines 
which arrived in damaged condition, and for which they furnish 
us a claim list signed by the railroad company. We issue a credit 
memo for $24.00. Purchased from the Premier Drug Co. terms 
2/10, n/3O, Patent Medicines, $802.00; Sundry Items, $698.00. 
Received a check for $605.64 from the Thomas Drug Co. 



DEPARTMENTAL ACCOUNTING 371 

invoice of October 21 in full. Sent our check for $175.00 to the 
New York Trust Company as the six months' interest due Octo- 
ber 31 on our Mortgage Payable. 
October 31. 

A shipment and invoice arrived from the United Chemical Co. for 
Raw Drugs, $310.00; Patent Medicines, $505.00; terms 2/10, 
n/30. Sold on account to the Thomas Drug Co. Raw Drugs, 
$218.00; Patent Medicines, $316.00; Sundry Items, $280.00. 

Required: 

1 i ) Open all books of original entry as directed and enter the fore- 
going transactions. Total and cross check the books. 

(2) Using a General Ledger, an Accounts Receivable Ledger, and 
an Accounts Payable Ledger, post the books of original entry. 

(3) Check the balance of the two control accounts with the totals 
of the individual account balances from the subsidiary ledgers. 

(4) Take a trial balance of the General Ledger. 



CHAPTER XX 
ACCOUNTING FOR THE MANUFACTURER 

INTRODUCTION 

All of the material presented to this point has been taken from 
trading and mercantile businesses. Nothing has been said 
about the accounting problems peculiar to the manufacturer. 
The trading or mercantile business buys a finished product, 
and sells it in the same condition. The manufacturer, on the 
other hand, buys raw materials and converts them, through his 
particular manufacturing process, into finished goods ready to 
sell. Some manufacturers only manufacture, their output being 
marketed by a distributing agency. Other manufacturers make 
and sell their product. The manufacturer who markets his own 
product will, of course, have to keep in addition to the records 
required by a manufacturer all the records of a trading company 
which we have studied thus far. We shall now look at some of 
the accounting problems met with by the manufacturer. 

The manufacturer does not buy a finished product at a price, 
but must buy the necessary raw materials and make the product. 
Obviously, a manufacturer must be able to sell his product after 
it has been manufactured, and he must sell it in competition 
with all organizations manufacturing the same item. The manu- 
facturer, therefore, must know his costs. He must be able to 
produce at a figure which will permit him to sell in competi- 
tion and at the same time make a profit. His costs must be 
accurate. This means usually a more elaborate and carefully 
planned system and set of accounts. 

THE SUBJECT OF COST ACCOUNTING 

In most schools teaching business administration, beside the 
fundamental accounting course, a separate course in Cost Ac- 
counting is usually included. It is not the purpose in this chap- 
ter to brief Cost Accounting, but rather to mention a few of the 
more important elements of Cost Accounting. We shall see 
how the accountant prepares data on costs, how the costs are 
gathered or summarized, and, finally, how the manufacturing 
statements are prepared. 

372 



ACCOUNTING FOR THE MANUFACTURER 373 

THREE ELEMENTS OF MANUFACTURING COSTS 

In manufacturing there are three principal elements of cost: 
i. Raw Materials, 2. Direct Labor required to convert the raw 
materials into finished goods, and, 3. The Indirect Manufac- 
turing Expenses. Those expenses which cannot be directly ap- 
plied to the cost of manfacturing are sometimes spoken of as the 
factory Overhead or Burden. Let us look for a moment at each 
of these three elements of cost. 

RAW MATERIALS 

Under this caption is included the cost of all materials which 
enter into and become a part of the item being manufactured. 
Materials used incidentally in the operation of the factory, such 
as coal to produce steam to propel the machinery, are not in- 
cluded in this group because the coal does not become part of 
the finished product. 

DIRECT LABOR 

We understand by direct labor the wages paid to those who 
are working directly on production, whose wages may be di- 
rectly charged to a particular job or process. Indirect labor, on 
the other hand, consists of all wages paid for services incidental 
to the process of manufacturing. In the first class, direct labor, 
would ordinarily be included wages paid to workers who oper- 
ate machines or tools in the manufacturing process, while the 
superintendent's salary and salary paid for the planning depart- 
ment are both part of the indirect labor cost. 

INDIRECT MANUFACTURING EXPENSE 

Indirect labor just differentiated from direct labor is one of 
the principal items under this caption. Indirect manufacturing 
expense or manufacturing overhead, as it is frequently called, 
includes all those manufacturing costs not included in the first 
two major divisions of costs. Such accounts, as taxes on factory 
buildings, factory property insurance, depreciation of factory 
machinery and equipment, are all good examples of accounts in 
this latter classification. 



374 FUNDAMENTALS OF ACCOUNTING 



THE MANUFACTURING STATEMENT 

Perhaps one of the best ways for a student to get a bird's-eye 
view of some of the features and peculiarities of accounts kept 
for a manufacturing enterprise is through a study of a Profit 
and Loss Statement used by a manufacturing company, to- 
gether with some of the supporting schedules. 

In this respect we shall present a profit and loss statement of 
a manufacturing company in condensed form, together with 
supporting schedules. 



THE USE OF SCHEDULES IN STATEMENTS 

The accompanying profit and loss statement of the Jordan 
Manufacturing Company, Inc. is presented as a condensed 
statement. In order fully to comprehend the activities of the 
company, one would have to study the supporting schedules. 
By the use of these schedules it is possible to get a profit and loss 
statement on one sheet of paper and make the entire operations 
visible. This would not, of course, be possible if all the materials 
presented in the schedules were worked into the Profit and Loss 
Statement. The statement would be rather long and hard to 
visualize. 

EXHIBIT B 
THE JORDAN MANUFACTURING COMPANY, INC., 

Statement of Income Profit and Loss for the year ended 
Dec. 31,19 

Gross Income from Sales $310,217.00 

Deduct Returns and Allowances . . 2,210.00 

Net Sales 308,007.00 

Deduct the Cost of Goods Sold: 

Inventory Finished Goods Jan. i . $ 25,200.00 
Add " Cost of Goods Manufactured " 

Schedule B i 217,443.00 

242,643.00 
Less Inventory Finished Goods 

Dec. 31 26,090.00 

Cost of Goods Sold $216,553.00 



ACCOUNTING FOR THE MANUFACTURER 375 

Gross Profit on Sales $ 91,454.00 

Deduct Selling Expenses Schedule B 2 39,770.00 

Net Selling Profit 51,684.00 

Deduct General & Administrative Ex- 
pense Schedule B j 19,268.00 

Net Profit from Operations $ 32,416.00 

Deduct Net Non-Operating Expense: 
Non-Operating Expense: 

Bond Interest $ 6,000,00 

Interest Expense ... 780.00 

Sales Discounts 2,460.00 

$ 9,240.00 
Less Non-Operating Income: 

Purchase Discounts . $ 1,020.00 

Rental Income 960.00 

Interest Earned 198.00 

2,178.00 

7,062.00 
Net Profit $ 25,354.00 



SCHEDULE B i 
Cost of Goods Manufactured 



Inventory Work in Process Jan. i . . . . 
Add Material Consumed: 

Inventory Raw Materials Jan. i . . 
Add Pur. Raw Mats. . . $180,000.00 

Freight Inward ^4^2._ 

180,640.00 
Less Returns 6,200.00 



Deduct Inv. Raw Mats. Dec. 3 1 
Cost of Materials used , 



Add: Direct Labor 

Manufacturing Expense 
Sched. M 



Deduct Inv, Work in Process Dec. 31 
Cost of Goods Manufactured 



$ 12,230.00 



274,440.00 

186,670.00 

14,712.00 



$ 20,135,60 



192,093.60 
20,104.00 

29,848.40 

242,046.00 

24,603.00 

$217,443.00 



376 FUNDAMENTALS OF ACCOUNTING 

SCHEDULE M 

Manufacturing Expenses 

Indirect Labor ................................. $ 8,630.00 

Indirect Materials: 

Old Inventory .......... $1,000.00 

Add Purchases .......... 1,500.00^ 

2,500.00 

Less New Inv ............ 1,300.00 

Materials and Supplies Used .................. 1,200.00 

Taxes ( factory) ............................... 600.00 

Royalties Expense .............................. 1,230.00 

Light, Heat & Power (factory) .................... 3,006.00 

Repairs & Maintenance of Machinery .............. 614.00 

Repairs & Maintenance of Buildings ............... 244.00 

Factory Superintendent .......................... 5,000.00 

Compensation Insurance ......................... 1,800.00 

Federal Old-Age Insurance Tax ................... 663.00 

Depreciation of Tools ............ . .............. 1,605.40 

Depreciation of Machinery ....................... 4,000.00 

Depreciation of Buildings ........................ _ I A5^ > 2. 

$29,848.40 

SCHEDULE B 2 
Selling Expenses 

Salesmen's Salaries .............................. $21,800.00 

Salesmen's Commissions ......................... 6,200.00 

Advertising .................................... 3,740.00 

Delivery Expense ............................... 3,620.00 

Freight Outward ............................... 810.00 

Sales Office Salaries ............................. 



SCHEDULE B 3 
General and Administrative Expense 

Taxes ......................................... $ 400.00 

Light, Heat & Power ............ . ............... 2 50.00 

Officers' Salaries ................................ 12,000.00 

Office Salaries ............ . ..................... 4,600.00 

Telephone & Telegraph .......................... 374-OO 

Office Supplies ................................. 814.00 

General Insurance .............................. 700.00 

Depreciation Office Equipment .................... 130.00 

$19,268.00 



ACCOUNTING FOR THE MANUFACTURER 377 

SCHEDULE OF COST TO MANUFACTURE 

The principal schedule is that of Cost to Manufacture, B i 
above. This schedule exhibits the several cost accounts re- 
quired to measure the cost to manufacture the product. This 
schedule is the major part of the Cost of Goods Sold section 
of the Profit and Loss Statement. For management purposes 
the schedule must be studied most carefully, because here is 
where the gross profit will be made or lost. For the manufac- 
turer the skill in manufacturing usually measures the success 
or the failure of the organization, rather than the skill of " buy- 
ing right/' which is so important to the mercantile or trading 
company. 

The schedule Cost of Goods Manufactured starts with the 
cost of the goods which were in process partly finished at the 
close of the last period. To this figure must be added the first 
element of prime cost, materials consumed. This figure is had 
by another separate calculation, as follows: To the inventory 
of materials on hand at the start of the period is added the cost 
of materials purchased during the period. From this total there 
must be subtracted the cost of the materials on hand at the 
close of the period. When this figure, the cost of raw materials 
consumed, has been added to the old Inventory of Work in 
Process, it will be necessary to add in also the total amount ex- 
pended for Direct Labor and the total of the Indirect Manufac- 
turing Expense Schedule M above. From the total thus ob- 
tained it will then be necessary to subtract the Inventory of 
Goods in Process at the close of the period in order to deter- 
mine the Cost of Goods Manufactured during the period, as 
exhibited in the principal statement under the caption Cost of 
Goods Sold. 

OTHER SCHEDULES 

The other schedules used in the condensed profit and loss 
statement are not limited to a manufacturing company but could 
be, and often are, used to good advantage by mercantile and 
trading organizations. The use of schedules in any financial 
statement is recommended at any time there are sufficient items 
to warrant their use. Had there been only two or three selling 
expenses, as would probably be the case if the manufacturer 



378 FUNDAMENTALS OF ACCOUNTING 

disposed of his entire output through a broker or agent, then a 
separate schedule for selling expenses would not have been re- 
quired. Similarly, if there had been several other " non- 
operating expense " or " non-operating income" accounts, then 
separate schedules might have been used there also. The use 
of schedules, of course, is not limited to the Profit and Loss 
Statement. On the Balance Sheet, schedules for such groups of 
accounts as Notes Receivable, Notes Payable, and Investments 
are quite common. 

ADJUSTMENTS AND CLOSING FOR MANUFACTURERS 

One of the principal differences in accounts used by the manu- 
facturer is the several different inventories necessary as con- 
trasted to the one inventory used by a trading concern. 

The three principal inventories found in a manufacturing 
company are (i) The Inventory of Finished Goods, (2) The 
Inventory of Work in Process, and (3) The Inventory of Raw 
Materials. In addition, we often find Inventories for indirect 
manufacturing materials and supplies. All of these inventories 
must be taken at the close of the period and placed on the books 
by proper adjustment entries. In order to gather together the 
expenses in the several important subdivisions of the profit and 
loss statement, the manufacturing company will operate for 
convenience in closing the books several summary accounts, 
rather than closing all nominal accounts into the Profit and Loss 
Summary Account. 

COST OF GOODS MANUFACTURED ACCOUNT 

One of the very important summary accounts used at the end 
of each period when the books of a manufacturer are adjusted 
and closed, is the " Cost of Goods Manufactured " account. 
The function of this account is to gather all costs pertaining to 
the cost of goods manufactured. All old Inventories pertaining 
to manufacturing will be debited as costs, and similarly all other 
costs, such as purchases of raw materials, manufacturing sup- 
plies, direct labor, indirect labor, and other indirect manufac- 
turing expenses. As all of these manufacturing costs are debited 
to the " Cost of Goods Manufactured " account, so also are the 
offsetting accounts credited to the same account. Such credits 



ACCOUNTING FOR THE MANUFACTURER 379 

are principally the current inventories of goods in process, raw 
materials, and manufacturing supplies. The net balance of the 
account is the Cost of Goods Manufactured, which in turn is 
transferred as a debit to the Trading Account. 



TRADING ACCOUNT 

This account is widely used to determine the profit on sales. 
The sales account is usually first closed to this account by a 
journal entry debiting the sales account and crediting the trad- 
ing account. The cost of goods manufactured, as described 
above, is the principal debit or cost. The next series of debits 
to this account closes the usual selling expenses such as listed in 
the schedule of Selling Expenses. The old inventory of Finished 
Goods is also closed to this account as a debit to trading, and in 
like manner the new or current inventory of Finished Goods by 
means of an adjusting entry is registered as a credit to the trad- 
ing account. The balance at this point indicates the net profit, 
or possibly loss, on trading, which figure is then usually closed 
by journal entry to the profit and loss summary account. 

PROFIT AND LOSS SUMMARY ACCOUNT 

After this account is opened with a credit indicating the net 
selling profit the usual general and administrative expenses are 
closed. The non-operating Income accounts are credited to 
Profit and Loss Summary account, while the non-operating ex- 
penses are similarly closed as debits to the Profit and Loss Sum- 
mary. The final net result will, of course, indicate a profit or 
loss for the period, and will be transferred to the proprietor's 
capital account, or in case of a corporation to the surplus 
account. 

DEMONSTRATION CASE 

In order to unify the closing of books for a manufacturer, to 
demonstrate the use of a work sheet designed for a manufac- 
turing company, and to illustrate some of the special problems 
in this regard we shall at this point introduce a complete demon- 
stration problem. As a starting point we shall, of course, need 
a before-closing trial balance taken from the books of a manu- 
facturing company. In order to conserve space this trial 



380 



FUNDAMENTALS OF ACCOUNTING 



fit JORDAX HAHUr ACTOR IK(J COMPAtt 
WORE SIBET - DECEMBER 31. 19 



ACCOUNTS 


I 


RIAL BALANCE 


AD JUS 


rXIHTS 


KANU'ACTORINa 


* 










Debits 


Credits 


Cash 


IE 
64 

2 

5 


t\ 
7 Z 

04 

8(0 


00 
00 

00 
00 




4 


870 


00 
































Reserve for Doubtful Accts. 
Holes Receivable 
Inventory Pin. Good* Jan. 1 


' Inventory Good* In Proc. Jan.i 
Inventory Raw Mat*. Jan. 1 
Inventory Hf|. Supplies Jan. 1 
Purch. of Kfg. Suppli e 
Lanfl 


6 

12 

1 
1 
10 


lib 
210 
0(0 

cdo 
oijo 


86 

00 
00 
00 
00 




























18 
1 
1 


30 
000 
800 


00 
00 
00 








Res. for*Dep. Buildings 
Machinery and Equipment 
Res. for Dep. Hach. and Equip. 
Tool. 


e 

46 

s 


000 
6Qf 


00 
40 




14 

18 


800 
600 


00 
00 











S 


i 

4 
2 


866 

600 
000 


00 

00 
00 






606 


40 








Office Equipment 
Re*, for Dep. of Off. Equip. 

Reu'salea ami Allowances 


8 

S 


840 
ejo 

nffi 


00 
00 




810 


860 
817 


00 

00 










<s> 




180 


00 






640 


uu 


















e 

34 

100 

raS 


800 
715 
000 
000 


00 
00 
00 
00 




























e 


too oo 


rir.t Hlge. 6t Bond* 
. JJO^I l|Mblt . , 


Surplus 
Direct Labor 
Indirect Labor 


100 
40 

1 


0(10 

<:a 

4(0 
4^0 


00 
00 
00 
00 










& 




614 
810 


00 
00 












SO 
8 


104 
680 


00 
00 








Factory Superintendent 
Taies 




0(0 
!0 
!B 

:< 


00 
00 
00 
00 




























1 
3 


600 
830 
006 
614 


30 
00 
00 
00 








Light. Heat and Power 
RePlr. and H.int. K.ch. 


Repair* and Mtlnl. 91<Jg- 


e 


00 


00 
00 
00 
00 






















1 


287 

860 


00 
00 




1 


963 


00 








SalssBcn's Salariei 
Salesmen's Coi.sions 
Advertising. 


Delivery Expense 
Prelght Outward 
Sale* Office Salaries 
Officers' Salaries 
Offlc. S.l.rl.. 


i 


8 
WO 
000 
600 


oc 

00 
00 
00 








































telephone and Telegraph 
Office Supplies 
General Insurance 
Bond Interest 
Interest Exeenss 


e 


914 


30 
30 

no 










fr 




f>0 


























lalei 6l .count. 
Purchase Discounts 
Rental Incos. 
Interest tamed 


e 








1 


080 
960 
180 


00 
00 
00 










<G> 




78 


00 
















NEW ACCOUNTS 
WEHTORIES Dec. 91. 


690 


4 


00 




006 


768 


00 














































finished Goods 
Vork in Process 
Rstr Material* 
















<jj 
























1 


84 

14 
1 


eoa oo 

718 00 

aoo oo 


Accrued Vafes 
Prepaid Advartlsin( 
Prepaid Cosp. Ins. 

DIPRICIATION OP 
















iv 


i 


860 
887 


00 
00 






84 


















M.ch. and Iqalp. 
Buildings 
Office Equipment 
Acc'd Interest Payable 
Acc'd Interest Receivable 



















4 

1 


500 

gee 

130 
78 


00 
50 

00 







360 


00 




4 


&00 
66 


00 
00 


























10 


645 


00 




10 


646 


00 










<fv> 


9 17 


|4j) QQ 




















64 


859 


0*9 




P1 


EJ^OJ) 

















































balance taken from the books of the Jordan Manufactur- 
ing Company, Inc., has been written on the working sheet 
above. It is assumed that the following adjustments are 
required : 

a. The Inventories at December 31, 19 were as follows: 

Finished Goods $26,090.00 

Work in Process 24,603.00 

Raw Materials 14,712.00 

Miscellaneous Mfg. Supplies 1,300.00 

Tools 2,000.00 



ACCOUNTING FOR THE MANUFACTURER 381 



TRAD 


NO 


ADMIIIISTRATW AND 
VON-OP ATIM 


BAUHCI 


SHUT 
Ubllitif, 
















CO 


JiQO 






























IE 
64 

t 


60 
718 

014 


00 
00 

00 




4 


870 


00 




































1? 


000 


00 












































{ 
46 


66 
000 


00 




16 
17 


460 
100 


00 
00 




I 


Riff 


00 




810 


817 


00 




















t. 


eoo 


00 






400 


00 












































84 
100 

1fl 


716 
000 
OflfJ 


00 
00 

flu 




































too 

40 


000 
418 


00 
00 




eoo 


000 


00 






















400 
850 


00 
00 




























ei 
c 
'a 


800 
200 

740 


00 
00 

no 












































8 

a 


eeo 

810 
600 


00 
00 
00 












is 


000 


00 















































874 
814 
700 
000 
7flO 


40 
00 
00 
00 
00 














































400 


00 




1 


080 
960 
108 


00 
00 
00 










































































CL> 


6 


000 


00 


















1 


86 
4 
14 
1 


090 
003 
718 
800 


00 
00 
00 
00 










































1 


1 


eeo 

87 


00 
00 






824 


00 






















iao 


00 














78 


00 






800 


00 



<$ 




OB4 




















G> 


61 


684 


00 




















JIM 


90 7 


9 




880 


f9? 


00 










1 


ill 


:ii. 




M 




35< 






























58 


8C 


00 




63 


80 


00 




410 


609 


00 




410 


600 


00 



































b. Accrued Salaries: 

Direct labor $ 614.00 

Indirect labor 210.00 

c. Taxes to be apportioned 60% to the factory and 407^ to the gen- 
eral and administrative expense. 

The light, heat, and power account has been analyzed and 
$250.00 should be charged as a general expense, the balance to 
the factory. 

d. Deferred Expenses: 

Prepaid Advertising $ 260.00 

Prepaid Compensation Insurance 1,237.00 



382 FUNDAMENTALS OF ACCOUNTING 

e. Depreciation is to be calculated as follows: 
Machinery & Equipment 10% per annum. 
Buildings 2% per annum. 
Office Equipment 5% per annum. 

/. Interest is to be accrued on Notes Payable amounts to $360.00; 
on Notes Receivable $78,00. 



WORK SHEET FOR A MANUFACTURER 

The accompanying work sheet has been designed to make 
easy the closing of the books by progressive steps and the prepa- 
ration of the Profit and Loss Statement, and necessary principal 
supporting schedules. 

The student will note from a study of this form that the trial 
balance after adjustment has been omitted. The next three 
pairs of columns have been provided to break down the nominal 
accounts into appropriate subdivisions of income and expense. 
The last two columns are used as before to receive the Balance 
Sheet accounts. The use of this Work Sheet can best be under- 
stood by tracing out some of the adjustment entries and study- 
ing the placing of the nominal accounts in their respective sub- 
divisions. In order to facilitate a study of the adjustment en- 
tries, each has been numbered. The first adjustment sets up 
the new Inventory of " Finished Goods" as an asset, and as an 
offsetting credit to the Trading division. Note that the inven- 
tory amounts are not written into the adjustments space; this 
is to conserve time. 

The second, third, and fourth adjustments, beside setting up 
the asset value of these inventories, are, similarly, placed di- 
rectly to the credit of the Manufacturing section account. 

The fifth adjustment is written in the adjustment columns, 
the debit representing the Tools Inventory or good tools on 
hand, which balance is, in turn, deducted from the Tools ac- 
count, which in our demonstration represents the cost of tools 
used in manufacturing. The balance of the adjustments six to 
fourteen inclusive are self-explanatory. The distribution of the 
accounts should be studied but needs no particular explanation. 
When the columns have been added, the " adjustments " col- 
umns will, of course, balance if the entries have been written 
correctly. The Manufacturing section columns, when added, 
will of course have a predominant debit balance, indicating the 



ACCOUNTING FOR THE MANUFACTURER 383 

Cost to Manufacture. This amount is transferred by entry 
No. 15 on the work sheet a debit to the Trading section and a 
credit to the Manufacturing section, thereby balancing the 
Manufacturing columns. Similarly, the next entry No. 16 
transfers the gross profit on Trading to the Profit and Loss col- 
umns. When the Profit and Loss columns have been added, the 
net profit or loss will be indicated. In our present problem there 
is a net profit of $25,354.00. This profit is, of course, also in- 
dicated in the balance sheet columns. 

From a work sheet, such as the one illustrated, the prepara- 
tion of a profit and loss statement is a comparatively simple 
matter. The accounts making up the Cost to Manufacture 
schedule are taken from the Manufacturing section of the work 
sheet. The Trading section of the work sheet provides the ac- 
counts for the Selling Expenses schedule and also the principal 
sources of income. The Profit and Loss section provides the 
accounts for the General and Administrative Expense sched- 
ule, also the non-operating expense and non-operating income 
acccounts. 

CLOSING ENTRIES 

After the work sheet has been prepared, and the financial 
statements presented to the management, the bookkeepers must 
turn themselves to the task of closing the books. In order to 
make our illustration complete the adjusting and closing entries 
are now presented. 



GENERAL JOURNAL 



Adjusting Entries 



Inventory Finished Goods Dec. 31 
Trading Account 

To set up the asset value of the current inventory of 
finished goods, and to reduce the cost of trading. 



Inventory Work in Process Dec. 31 
Inventory Raw Materials Dec. 31 
Inventory Manufacturing Supplies Dec. 31 
Manufacturing Account 

To set up the asset value of current manufacturing 
inventories and to reduce the cost to manufacture. 



26,090 


oo 


24,603 


00 


14,712 


00 


1,300 


00 



26,090 oo 



40,61500 



FUNDAMENTALS OF ACCOUNTING 



-3- 

Tools Inventory Dec. 31 
Tools 

To set up the asset value of tools on hand, and reduce 
the tools expense account. 



-4- 



Direct Labor 
Indirect Labor 

Accrued Wages 

To set up accrued wages. 

Prepaid Advertising 
Advertising 

To defer the prepaid advertising. 

-6- 

Prepaid Compensation Insurance 
Compensation Insurance 

To defer the prepaid compensation insurance. 

Depreciation of Machinery and Equipment 
Reserve for Dep. of Mach. and Equip. 

10% annual rate. 

-8- 
Depreciation of Buildings 

Reserve for Dep. of Buildings 

2% annual rate. 

-9- 
Depreciation of Office Equipment 

Reserve for Dep. of Office Equipment 

5% annual rate. 

-10- 

Interest Expense 

Accrued Interest Payable 

To accrue interest on Notes Payable. 

-ii- 

Accrued Interest Receivable 
Interest Earned 

To accrue interest earned on Notes Receivable 
Closing Entries 



Manufacturing Account: 
Goods in Process Jan. i 
Raw Materials Jan. i 
Manufacturing Supplies Jan. i 
Purchases of Manufacturing Supp. 
Tools Expense 
Freight Inward 
Purchases of Raw Materials 



2,000 


oo 










2,000 


oo 


614 


oo 






210 


oo 










824 


oo 


260 


oo 










260 


00 


1,237 


00 










1,237 


oo 


4,500 


oo 










4,500 


oo 


1,256 


oo 


1,256 


00 


130 


oo 










130 


oo 


360 


00 


360 


oo 


78 


oo 


78 


00 


264,258 


00 










20,135 


60 






12,230 


oo 






1,000 


00 






1,500 
1,605 

640 
180,000 


oo 

(.0 

00 

oo 



ACCOUNTING FOR THE MANUFACTURER 385 



Direct Labor 

Indirect Labor 

Factory Superintendent 

Factory Taxes 

Royalties Expense 

Light, Heat & Power (factory) 

Repairs & Maintenance Mach'y 

Repairs & Maintenance Bldgs. 

Compensation Insurance 

Depr. of Machinery & Equip. 

Depreciation of Buildings 

To close all manufacturing expense to the Manufactur- 
ing Account. 

-2- 

Purchase Returns and Allowances 
Manufacturing Account 

To reduce the manufacturing cost by the amount of 
Purchase Returns and allowances. 

-3- 
Trading Account 

Manufacturing Account 

To charge Trading with the Cost of Manufacturing, 
closing the latter account. 

-4- 
Trading Account: 

Inventory of Finished Goods Jan. i 
Sales Returns and Allowances 
Salesmen's Salaries 
Salesmen's Commissions 
Advertising 
Delivery Expense 
Freight Outward 
Sales Office Salaries 

To charge the Trading Account with the beginning in- 
ventory of finished goods and the several selling ex- 
penses. 

Sales 

Trading Account 

To close the sales for the year to the Trading Account. 

-6- 
Trading Account 

Profit and Loss Summary 

To transfer to the Profit and Loss account the net 
profit on selling. 

-7- 
Profit and Loss Summary: 

Taxes (General) 

Light, Heat, and Power (General) 

Officers' Salaries 

Office Salaries 

Telephone and Telegraph 

Office Supplies 

General Insurance 







20,104 


oo 






8,630 


oo 






5,000 


00 






600 


oo 






1,230 


00 






3,006 


oo 






614 


00 






244 


oo 






1,963 


00 






4,500 


oo 






1,256 


oo 


6,200 


oo 










6,200 


00 


217,443 


00 










217,443 


oo 


67,180 


00 










25,200 


oo 






2,210 


oo 






21,800 


00 






6,200 


oo 






3.740 


00 






3,620 


oo 






810 


oo 






3,600 


oo 


310,217 


oo 










310,217 


oo 


51,684 


00 


51,684 


00 


28,508 


00 










400 


00 






250 


00 






12,000 


oo 






4,600 


oo 






374 


oo 






814 


00 






700 


00 



386 



FUNDAMENTALS OF ACCOUNTING 



Bond Interest 
Interest Expense 
Sales Discounts 
Dep. of Office Equipment 

To close the several general, administrative, and non- 
operating expenses to the Profit and Loss account. 

-8- 

Purchase Discounts 
Rental Income 
Interest Earned 

Profit and Loss Summary 

To close the non-operating income to Profit and Loss. 

-9- 

Profit and Loss Summary 
Surplus 

To close the net profit for the year from Profit and Loss 
to Surplus. 



ADJUSTING AND CLOSING ENTRIES POSTED 

After the adjusting and closing entries have been posted, all 
of the nominal accounts will have been closed. The following 
accounts are now exhibited so that the student may visualize 
the effect of the adjustment and closing entries. 

MANUFACTURING ACCOUNT 







6,000 

780 

2,460 
130 


00 

oo 
oo 

00 


1,020 
960 
198 


oo 

00 
00 


2,178 


00 


25,354 


00 


25,354 


00 



Closing Entry No. (i) 


264,258.00 


Adjustment No. (2) 
Closing Entry No. (2) 
Closing Entry No. (3) 


40,615.00 
6,200.00 
217,443.00 


264,258.00 


264,258.00 



TRADING ACCOUNT 



Closing Entry (3) 
Closing Entry (4) 
Closing Entry (6) 


217,443-00 
67,180.00 
51,684.00 


Adjustment No. (i) 
Closing Entry No. (5) 


26,090.00 
310,217.00 


336,307.00 


336,307.00 



PROFIT AND Loss SUMMARY 



Closing Entry (7) 
Closing Entry (9) 


28,508.00 
25,354-00 


Closing Entry (6) 
Closing Entry (8) 


51,684.00 
2,178.00 


53,862.00 


53,862.00 



CONCLUSION 



A great deal more could be said about the peculiar problems 
of cost accounting for the manufacturer, but that shall be left 



ACCOUNTING FOR THE MANUFACTURER 387 

for a separate course of study, as indicated in an early part 
of this chapter. It is hoped, however, that the student will 
appreciate the material presented and perhaps visualize some 
of the problems which abound in the interesting field of Cost 
Accounting. 



QUESTIONS ON THE CHAPTER 

1. Name and give a brief description of the three elements of 
manufacturing cost. 

2. Draft a skeleton profit and loss statement in condensed form. 

3. Explain the purpose and the use of three schedules which might 
be used. 

4. Draft a skeleton form for Cost, of Goods Manufactured. 

5. What, do you understand by factory overhead? 

6. Name and describe the use of four inventory accounts likely to 
be found on the books of a manufacturer. 

7. Explain how these Inventories Old and New are debited 
and credited to the several sections of the Profit and Loss account. 

8. Explain the function of three accounts used in the progressive 
steps required to close the books of a manufacturer. 

9. (a) Name the columns used on a work sheet designed for a 
manufacturer. 

(b) Explain the function of each of the several pairs of 
columns. 

10. (a) List ten accounts which might be listed as debits to the 
manufacturing section of the work sheet. 

(b) List the principal credits to this section. 

(c) What does the balance represent? 



388 



FUNDAMENTALS OF ACCOUNTING 



PROBLEM MATERIAL 



PROBLEM i 

The Simplex Machine Parts Co. Inc., who have been manufacturing 
automobile parts for several years, close their books semi-annually. 
The following is a trial balance taken from the general books of the 
Company at October 31, 19 . 

Purchase Raw Materials $183,600.00 

Sales Discounts 6,412.00 

Indirect Materials May i 1,200.00 

Purchase Discounts $ 3,620.00 

Purchase Returns 6,220.00 

Shipping & Receiving Expense 3,260.00 

Direct Labor 22,060.00 

Indirect Labor 8,645.00 

General Office Salaries 8,050.40 

Factory Executive Salaries 7,000.00 

Sales 320,460.00 

Return Sales 2,240.00 

Freight & Cartage 2,500.00 

Containers, Cartons & Boxes 2,310.00 

Purchases Indirect Materials 1,700.00 

Salesmen's Salaries 11,800.00 

Salesmen's Commissions 3,060.00 

Electric Service 2,012.00 

Repairs & Maintenance of Machinery 3,400.00 

Tools 3,200.00 

Machinery & Equipment 60,000.00 

Factory Buildings 52,000.00 

Office Building 10,000.00 

Land & Plant Site 12,000.00 

Accounts Receivable 64,260.00 

Vouchers Payable 82,420.00 

Cash 42,497.60 

Interest Expense 348.00 

Notes Payable 8,000.00 

Reserve for Doubtful Accounts .... 630.00 

Reserve for Dep. of Buildings 6,270.00 

Reserve for Dep. of Mach. & Equip. 18,600.00 

Advertising 12,000.00 

Insurance 840.00 

Officers' Salaries 12,000.00 

Inventory Raw Materials May i . . . 15,230.00 

Inventory Unfinished Parts May i . 22,415.00 

Inventory Finished Parts May i . . . 28,600.00 

Unissued Capital Stock 75,000.00 

Authorized Capital Stock 200,000.00 

Surplus 33,420.00 

$679,640.00 $679,640.00 



ACCOUNTING FOR THE MANUFACTURER 389 

Adjustment Data: 

October 31 Inventories are as follows: 

1. Raw Materials $21,410.00. 

2. Unfinished Parts $23,690.00. 

3. Finished Parts $32,500.00 

4. Indirect Materials $1500.00. 

5. Tools Inventory $2600.00. 

6. The Company is indebted to the Sterling Motor Co. $1500.00 
for Royalties, for patented parts manufactured during the cur- 
rent period, but which have not been recorded on the books. 

7. Depreciation of Buildings (Factory and Office) 2% per annum. 

8. Depreciation of Machinery 10% per annum. 

9. Salesmen's Salaries are to be accrued $5 10.00. 

10. Salesmen have earned in commissions $1020.00 which have not 
been recorded. 

11. General Office Salaries are to be accrued $605.00. 

12. There is Unexpired Advertising valued at $2000.00 

13. The Containers, Cartons, and Boxes account has been analyzed 
and it is found that $460.00 was spent for original containers, 
and the balance for shipping cartons and boxes. 

14. The Insurance Account should be charged $310.00 to the Fac- 
tory, the balance to General Expense. 

15. The Freight and Cartage Account has been analyzed $1240.00 
Inward Freight and $1260.00 Outward Freight. 

1 6. The Shipping and Receiving Dept. Expense has been analyzed 
$360.00 for receiving while $2900.00 is to be charged for out- 
ward shipments. 

17. The Electric Service is to be apportioned $1940.00 to Factory, 
balance to General. 

18. The Reserve for Doubtful Accounts is to be increased by i% 
of Accounts Receivable. 

Required: 

(1) Prepare an accountant's work sheet. 

(2) Prepare a condensed profit and loss statement, with schedules 
for Cost of Finished Parts, Manufacturing Expenses, Selling 
Expenses, and General Administrative Expense. 

(3) A balance sheet. 

(4) Journal entries required to adjust and close the books. 

(5) Post ledger accounts for Cost to Manufacture, Trading, and 
the Profit and Loss Summary. 



CHAPTER XXI 
THE VOUCHER SYSTEM 

NEED FOR THE VOUCHER SYSTEM 

In a small organization the proprietor may be able to super- 
vise personally all the details of his business including all ac- 
counting matters, but in larger organizations a great deal of the 
authority must be delegated to assistants. The accounting au- 
thority may be in the hands of a treasurer, one of the officers of 
a corporation. He, in turn, may engage a controller to super- 
vise the entire accounting. The controller may delegate the 
several phases of his work to junior executives. A general audi- 
tor may be appointed by the treasurer or controller to audit or 
keep a continual check on the accounting system which will 
provide a double check on all important accounting procedure. 
Such a system, requiring two or more individuals to handle the 
same items or to pass on, check, or approve the procedure, is 
known as a system of internal check. 

System building is one of the most interesting fields of ac- 
counting. Standard forms such as those illustrated in our chap- 
ters on special journals are quite satisfactory in theory and may 
be found in use by business organizations in similar or modified 
form. However, while each of the forms illustrated is a perfect 
general form, frequently in practice many modifications of these 
forms will be found necessary, and it is not infrequent that a 
student starting to work in an accounting department will meet 
forms which may be rather strange to him. This is because 
some accountant has designed a book or system which will best 
fit the needs of the particular organization. Custom-built sys- 
tems are usually much more efficient because they are planned 
to fit the needs of the particular business. System builders 
always strive to create a system that will yield the maximum 
of information with the minimum of effort. In this chapter one 
or two of the special books employed by system builders will be 
presented in a study of the modern voucher system. 

39 



THE VOUCHER SYSTEM 391 

VOUCHER SYSTEM DEFINED 

The title Voucher System might indicate a complete account- 
ing system different from the general system of accounts studied 
so far. This is not entirely true, because the voucher system 
replaces only certain books in the system, principally the Pur- 
chase Journal, and the Accounts Payable Ledger. The Cash 
Disbursements Journal will be simplified, but the other books, 
including the General Ledger, will continue practically un- 
changed. 

A Voucher Register, a new special journal, together with a 
new procedure for verifying, recording, and filing of " vouch- 
ers " and a new procedure for " vouching " all cash payments, 
are the principal changes to be introduced in a study of the 
voucher syatem. 

VOUCHER DEFINED 

A definition of " voucher " taken from a standard dictionary 
is as follows: " An instrument which attests, warrants, main- 
tains, or bears witness; a document which serves to vouch the 
truth of an account/ 7 This definition is quite satisfactory and 
accurately defines a voucher. In the voucher system a voucher 
is prepared for every purchase of material, merchandise, assets, 
or services. With the voucher system in operation, all pay- 
ments will be made by voucher check except, of course, petty 
cash disbursements which will be handled as always. 

VOUCHER DESCRIBED 

Sometimes the instrument is drawn as a separate, complete 
instrument. The " inside " or " face " of the voucher is then 
ruled but otherwise left blank for typing the details of the pur- 
chase. The reverse or " outside " of the voucher is printed in 
such a way that, when folded, the summary and distribution 
information will appear in readily usable form as an aid to the 
bookkeeper in entering the voucher in the register. Sometimes 
this form will be printed only on the " outside/' the inside be- 
ing blank. In this case the form is spoken of as the voucher 
jacket. When a voucher jacket is used the original invoice is 
fastened on the inside of the jacket and makes a very good 



392 FUNDAMENTALS OF ACCOUNTING 

voucher. If there is no invoice, as in the case of a voucher 
drawn for pay-roll, then a description of the disbursement is 
typed on the inside of the voucher jacket if the outside summary 
is not sufficient. 

VOUCHER JACKET ILLUSTRATED 

The voucher jacket is usually a blank sheet of paper of ap- 
proximate letter size, 8^ by 1 1 inches. This is then printed on 
just one-half the sheet, as indicated in the following illustration, 
so that after the voucher is fastened inside the jacket and 
folded for vertical filing, the printed matter will be on the out- 
side of the jacket. 

An experienced voucher clerk prepares the vouchers from in- 
voices previously approved and checked as to quantity, quality, 
and price in accordance with the purchase order. The infor- 
mation appearing on the outside of the jacket is taken from the 
invoice so approved. 

In the voucher system each voucher jacket bears a regis- 
tered number, and each line in the voucher register likewise is 
registered. If for any reason a voucher has to be canceled, 
then the voucher jacket is plainly marked canceled and the 
line bearing the canceled number will be left blank, or the word 
canceled written in. The voucher so canceled is then filed in 
a compartment available for auditing purposes. The informa- 
tion printed on the following form is merely typical of what 
might appear on the voucher jacket. The accounts to be 
charged correspond with the account distribution in the voucher 
register, and of course may contain a great many more accounts. 
Sometimes, instead of printing a long list of accounts which 
may be charged, space is simply provided for " writing in " the 
particular account to be debited, and this account title will be 
written in by the voucher clerk instead of checking a printed 
account title as in the illustration. The inside of the voucher 
is quite frequently left blank, because the original invoice from 
the seller fastened to the jacket gives the best record of the 
item to be paid by the voucher. 

The invoices which go into the voucher, as described before, 
are usually first checked with the purchase order. It is also 
the duty of the voucher clerk to see that all initials are in order, 



MODERN MANUFACTURING CO. 




Strong Hardware Co. 
245 Central Ave. 



New Brunswick, N. J. 



Total of Invoice 

Terms 

Discount 

Net Amount Payable 

Due Date 



$100.00 



2/10 n/30 



$2.00 



$98.00 



Jan. 12 



Paid: Date Jan. 10 Check No. 286 



Distribution 



Accounts to be Charged 



Amount 



Purchases-Raw Materials 

Freight Inward 

Direct Labor 

Pur chases- Indirect-Supplies 

General Office Pay-Roil 

Sales Dept. Salaries 

Advertising 

Delivery Expense 

Rent 

Insurance- General 

Insurance- Factory 

Light, Heat, Power 

General Expense 

Sundry-Account / i 

Approved ' 



Entered., 



100 



00 



394 FUNDAMENTALS OF ACCOUNTING 

approving quantity, price, and so forth before he accepts the 
invoice and prepares the voucher for entry and payment. 

If the voucher is being prepared to pay for a service, rather 
than an invoice, such as pay-roll, then the pertinent informa- 
tion relative to the pay-roll being paid by the voucher will be 
typed on the inside of the voucher and take the place of an 
invoice. 

As the vouchers are thus completed, they are turned over to 
the bookkeeper for entry in the voucher register. 



VOUCHER REGISTER ILLUSTRATED 

The following voucher register form is presented to illustrate 
principles and possibilities of the voucher system, rather than 
as an ideal form to be used by any particular business. 

The form is printed in loose leaf to meet the needs of a par- 
ticular company. As the name of the book indicates, it is a 
register; that is, each line bears a registered number to cor- 
respond with the voucher, and if the system is operated properly 
each voucher will be entered on its own line, as previously 
explained. 

Because the voucher gives so much detail regarding the item, 
there is no need to write in any explanation. The voucher num- 
ber is reference enough, and, should an interested person care 
to study any particulars, he can easily locate the voucher by 
number and examine it. 

The first money column headed Accounts Payable is reserved 
for the voucher total. The sum of this column is posted at the 
end of the month to the credit of the Accounts Payable Con- 
trolling Account in the general ledger. All the remaining money 
columns to the right are reserved for the distribution of the 
items involved, as indicated on the voucher jacket. Each of 
the distribution columns is a debit column and represents an 
account kept in the general ledger. Perhaps a good way to 
understand the book and its operation will be to trace out the 
entry of a few vouchers. 

Voucher i, taken from the voucher jacket illustrated, indi- 
cates a purchase of $100.00 worth of Indirect Supplies from the 
Strong Hardware Company. The total is entered in the Ac- 
counts Payable column, and the amount extended to the Pur- 







[ 










g 




ss 

00 J* 




I i 




35 









^-c 








IP | 


\ \ 






3- 




8 - 




ss 

15 S3 




E - 


s 


1- en 


g 


...... g -. 


t 


10 


I 


s- 


1 


u, 


^ 


- 





P 


Jl_ 


_ 1" 


ft 








J M 


%3 


L 


g s 




II 


s I r 


S - 




42g 








^ 









s 




1 = 




sS 


g 


s - 




>iS 

SB 


= I r 


3 = 








. - .-. 




52 


. b- - _. 


2 - 




S ? 




o - 




ill 1 


" t " - 


s? 












J M J c 









is: i 




|s 












SEE s 




g - 




Ii F " 




; t 




! 








K s 




g 




ss* i 




s 






\ J^ 






aiJ : 




s - 




|3S - 








S 








gg 




g - 




l>s - s' 




- 










8 


2^5 S 


= = = ae =r= == 




t 


ISs i 




g J 


* 


S 









; 8 


g s g (_ 


. 


t 


W u o Q " 
Jjj. o> S S 


525 t 


g* 




1*1 




s 




..B..J 

B 
















8 


a I* o ( 






e s " s " 


sis f 






1 ISii 


3^t i 






4 


i \ 






"*TT ' ' " 















396 FUNDAMENTALS OF ACCOUNTING 

chases Indirect Supplies column. Voucher 2 is for the purchase 
of some sort of " Office Equipment " the invoice attached 
to the voucher would indicate the exact item. Because the ac- 
count " Office Equipment " has not been given a special col- 
umn, it is entered as one of the Sundry Accounts. Special 
columns are provided for the convenience of posting accounts 
which are used frequently, whereas accounts which are used 
seldom are entered in the Sundry Account space and the amount 
in the sundry money column, from where it is posted to the 
general ledger. Voucher 3 is for a purchase of Raw Materials, 
and will be treated the same as voucher i. The fourth voucher 
represents an invoice from the Pennsylvania Railroad for 
freight charges, perhaps on the shipment of Raw Materials 
above. Very frequently an express or freight bill will be at- 
tached to the bill of lading, and will have to be paid in cash 
unless the company has established a credit rating with the 
carrier, as is assumed here. Voucher 5 is a pay-roll voucher. 
Typed on the inside of this voucher would be a brief descrip- 
tion of the several pay-rolls being charged. The summary by 
departments is then indicated on the outside of the jacket for 
posting information. The regular pay-roll books would, of 
course, be maintained, and therefore only a brief summary need 
be indicated in the voucher. The sixth voucher indicates the 
purchase of an automobile delivery truck. Note that the De- 
livery Equipment account is listed among the sundry accounts. 
The seventh voucher evidently covers two policies, one charge- 
able to general insurance, and the other to factory insurance 
The Public Service Light and Power Company, voucher No. 8 
no doubt represents $180.00 electric power chargeable to th< 
factory, while 60.00 is classified as a general expense, perhap: 
for. lights. The last voucher listed, No. 9, is no doubt for Ga 
and Oil used in the delivery truck, and therefore chargeable t< 
Delivery Expense. 



SUMMARY POSTING AT THE END OF THE MONTH 

At the end of the month the totals of each column are poste 
to the respective accounts in the General Ledger. The Sundi 
Amount column has been posted to the individual accounts ar 



THE VOUCHER SYSTEM 



397 



is therefore checked. The Accounts Payable credit posting off- 
sets the series of total debit postings, the total of which should 
exactly equal the total credited to the Accounts Payable Con- 
trolling account. 

FILING THE VOUCHERS 

Several methods of filing vouchers are in use. One system 
very widely used maintains just two filing cabinets. One is for 
" Unpaid Vouchers " and the other for " Paid Vouchers." As 
soon as a voucher is entered in the register, it is filed with the 
Unpaid Vouchers, where it will remain until paid, after which 
it will be filed with the Paid Vouchers. In this manner the 
Accounts Payable Ledger is eliminated. The Accounts Pay- 
able Controlling account will indicate the total due to creditors. 
The total of all unpaid vouchers taken from the " Unpaid 
Voucher " file should equal this amount. This elimination of 
the subsidiary creditors ledger and the numerous postings to 
the individual creditor's accounts is one of the important labor- 
saving advantages of the voucher system. 

Some accountants, however, like to maintain summary records 
with each creditor. This is easily accomplished by the addi- 
tion of a file for creditors. A card is made out once for each 
creditor and may be ruled as follows : 



STRONG HARDWARE COMPANY 

245 Central Ave. 
New Brunswick, N. J. 



Payment Reference 



Vouchers Payable 



Date 



Vo. No. 



Aral. 



Date 



Vo. No. 



Ant. 



Jan. 8 



100.00 



The use of such a card file simply replaces the Accounts Pay- 
able Ledger, and requires just about the same amount of time 
and labor to operate. 



FUNDAMENTALS OF ACCOUNTING 



PAYMENT OF VOUCHERS 
THE VOUCHER CHECK 

As vouchers are to be paid, they are taken from the Unpaid 
Vouchers file and checks drawn for the proper amounts. The 
voucher system usually includes the use of voucher checks. 
A voucher check is one prepared to indicate definitely the items 
being paid by the check, and containing some statement as 
follows: " Acceptance of this check acknowledges payment in 



THE MODERN MANUFACTURING CO. No. 495 

NEW BRUNSWICK, N. J. 19 



THE NATIONAL BANK OP NEW JERSEY 
88-170 NEW BRUNSWICK. N. J, 



THE MODERN MANUFACTURING CO. 

New Brunswick, N. J. 

Pay to Order Of. $ 



No. 495 



TO: THE NATIONAL BANK OF NEW JERSEY 
New Brunswick, N. J. 



DOLLARS 



THE MODERN MANUFACTURING CO. 
By Treas. 



Please Detach Before Depositing 

Acceptance of this check acknowledges payment in full of the 
below listed items. 

No- other receipt is required. 

If any error occurs please return the check with your advice. 



Date 


Item 


Total 


Discount 


Check 
Ami. 













THE VOUCHER SYSTEM 



399 
In 



full of the following items and no other receipt is required, 
case of error please return the check with your advice." 

This is followed by a brief summary of the payment, as in the 
two illustrated types of voucher checks. 



THE CHECK REGISTER 

With the voucher system in operation the Check Register, or 
cash payments journal, becomes a very simple form, such as 
the following : 



CHECK REGISTER 


Date 


Payee 


Ck. No. 


Voucher 
Number 


P 


Vouchers 
Payable 
Debit 


Purch. 
Disct. 
Cr. 


Net 
Cash 
Cr. 


~^_^ 


^ -^ 


. ^ 






^- ^~ 


*^~s^ 





Since the voucher register records a voucher for every dis- 
bursement, except for petty cash payments, the check register 
is simply a cash record of voucher payments. The only post- 
ings from the check register illustrated are the column totals. 
The first money column is posted to the debit of the ,<4c0w,s 
Payable Controlling account, and is offset by two credit post- 
ings, one to Purchase Discounts and the other to Cash for the 
net amount disbursed. 



VOUCHERS REQUIRING IMMEDIATE PAYMENT 

Sometimes an item must be paid immediately. In such a 
case the procedure will be the same as where time elapses 
between the drawing of the voucher and its payment, except 
that the voucher will not, of course, be filed with the unpaid 
vouchers. As a matter of speeding up the transaction, often 
the check will be drawn first, and the authenticating voucher 
drawn immediately following, as would be the case if some- 
one were waiting for a check. In such a case a voucher number 
would be assigned to the payment and written on the voucher 
part of the check. An illustration of this might be a check 
drawn to an express company where the amount is too large 
for a petty cash disbursement. A disbursement for pay-roll calls 



400 FUNDAMENTALS OF ACCOUNTING 

for an immediate payment of cash, but here the usual pro- 
cedure is followed. The voucher is drawn, approved for 
payment, recorded in the voucher register, where the several de- 
partments are debited and the accounts payable controlling ac- 
count credited. The check is drawn and entered in the check 
register, resulting in a debit to the accounts payable controlling 
account and a credit to cash. The payment notation is then en- 
tered in the space provided on the face of the voucher jacket and 
the voucher placed in the " Paid Vouchers " file. In each case 
the net result is the same, a debit to an expense account and a 
credit to cash, even though two books were required in each 
instance. 

PROCEDURE FOR PURCHASE RETURNS AND ALLOWANCES 

If returns are made from a shipment before the voucher is 
prepared, particularly if the return has been allowed, then the 
amount of the return will be simply deducted from the face of 
the invoice and the voucher prepared for the net sum. If a 
credit memo is received for returns or allowances after the 
voucher has been prepared and entered, then a journal entry 
will have to be written in the general journal, as follows: 

GENERAL JOURNAL 

National Steel Company $200.00 

Purchase Returns $200.00 

Received a credit memo for materials 
returned not as per specifications. 

If the voucher has been entered but not yet paid, then the 
voucher will be paid less the credit memo, the credit memo 
simply being fastened in the correct voucher and the amount 
deducted. If, on the other hand, the voucher has been entered 
and paid, a Voucher Debit Memo, printed on pink or other 
colored paper, is prepared and held for deduction from the next 
voucher prepared for the same company. In the meantime the 
debit will be posted to the Accounts Payable Controlling ac- 
count, should the month close before another purchase is made 
from the same company. This will have the effect of carrying a 
creditor's account with a debit balance, and where the amount 
involved is not considerable it should cause no criticism. Should 



THE VOUCHER SYSTEM 401 

no further purchases be made from the creditor, a check will be 
requested, and, when received, will be debited to Cash and 
credited to Accounts Payable Controlling account, thus balanc- 
ing the transaction. 

PROCEDURE INVOLVING NOTES PAYABLE 

Suppose the company borrows $2000.00 from the bank for 
sixty days. At the time the loan is granted, a journal entry will 
be written in the usual way. Debiting Cash for $1980.00 the 
net amount credited by the bank, Interest Expense may be 
debited for the other $20.00, while Notes Payable is credited 
with $2000.00. When payment becomes due, because all pay- 
ments are made by voucher, a voucher is drawn and entered in 
the voucher register, resulting temporarily in a debit to Notes 
Payable (through the Sundries column) and a credit to Vouch- 
ers Payable. (The Vouchers Payable account is purposely used 
in this illustration, in place of the Accounts Payable Controlling 
account which has been used in all previous illustrations, so 
that the beginning student might see that these accounts repre- 
sent exactly the same thing and may, therefore, be used inter- 
changeably.) The voucher is immediately paid through the 
check register, resulting in a debit to Vouchers Payable and a 
credit to Cash. This may seem like a rather involved procedure, 
but really is very simple. 

Should a voucher already on the books be paid by the issu- 
ance of a note payable, a journal entry may be written in the 
general journal debiting Vouchers Payable, and crediting Notes 
Payable. If space has been provided in the voucher register for 
payment data, as will be explained presently, then in this space 
a note may be written, indicating that this voucher has been 
paid and giving a cross reference to the journal entry. When 
the note is paid at maturity, the same procedure should be fol- 
lowed as outlined above when the bank note became due. 

PROCEDURE FOR PARTIAL PAYMENT 

If, when an invoice is received, the seller agrees to accept 
several partial payments, several vouchers should be prepared, 
and each voucher paid as it matures, involving no other special 
procedure. If partial payments are agreed upon after the 
original voucher has been entered, then the original voucher 



402 



FUNDAMENTALS OF ACCOUNTING 



may be canceled and two new vouchers prepared, one for the 
amount to be paid, and the other for the deferred balance. For 
example, suppose Voucher 6 in favor of the Rutgers Auto Ex- 
change due February yth is to be paid $500.00 February yth 
and the balance $450.00 March yth. The easiest procedure will 
be to draw two new vouchers, say Nos. 55 and 56. The payee, in 
each instance, will be Rutgers Auto Exchange, and the amounts 
will be entered in the Accounts Payable credit column and the 
debits will also be entered in the Accounts Payable Controlling 
account, in the Sundry Accounts space. In this manner the 
credit from Voucher 6 is balanced off or canceled, while the two 
new credits are recorded. In the space provided for payment 
data a notation " see Vouchers 55 and 56 " will show clearly the 
disposition of the first voucher. The two new vouchers will, of 
course, explain that they are in payment of the old voucher. 
Such a situation should not be met with frequently, for this prac- 
tice indicates a poor current financial condition. 



THE VOUCHERS CONTROLLING ACCOUNT 

When the voucher system is in operation, frequently the 
Accounts Payable Controlling account will be given the title 
Vouchers Payable Controlling account as indicated in one of the 
previous illustrations. Either title is satisfactory, but the writer 
can see no advantage in changing the name from Accounts 
Payable Controlling to Vouchers Payable Controlling. The 
entries in the control account will appear as follows : 

ACCOUNTS PAYABLE CONTROLLING ACCOUNT 



Jan. 31 Cash Paid to Creditors 


Jan. i 


Balance brought down 


xxx 


from Check Register xxx 


Jan. 31 


Total Vouchers Pay- 




General Journal xxx 
From "Sundry" 




able from Voucher 
Register 


xxxx 


Accounts column 








Voucher Register 








(for canceled 








vouchers, etc.) xxx 








xxxx 






xxxx 




Feb. i 


Balance 


xxx 



The student will note that the debits and credits to this ac- 
count are just about the same as formerly written in the Ac- 



THE VOUCHER SYSTEM 



403 



counts Payable Controlling account. The principal credit now 
comes from the voucher register instead of from the purchase 
journal. The principal debit comes from the check register in- 
stead of a special column of the cash disbursements journal. 
The general journal is utilized very much the same as always, 
and is used to record notes given to creditors and for purchase 
returns and allowances, as previously explained. 



OTHER FORMS OF VOUCHER REGISTER 

As was stated at the start of this chapter, voucher systems 
are frequently custom-made', that is, drawn to meet particular 
needs. The one form of voucher register illustrated would per- 
haps serve the needs of a small manufacturer. The voucher 
system, while very widely used by manufacturers as a part of a 
cost system,, is by no means limited to manufacturing concerns. 
Mercantile organizations very frequently employ the voucher 
system; for instance, a small department store might class its 
sales by departments and at the same time wish its purchases 
segregated similarly. The voucher system could be easily set 
up somewhat as follows: In the illustration below only the Ac- 
counts Payable total credit column is shown, together with an 
idea of how the several department purchases could be set up. 



VOUCHER REGISTER 


Accounts 
Payable 
Credit 


Purchases 
Dept. A 


Purchases 
Dept. B 


Purchases 
Dept. C 


Purchases 
Dept. D 


Purchases 
Dept. E 


E T 
T C. 


Debit 


Debit 


Debit 


Debit 


Deb.it 

































The balance of the distribution columns would be similar to 
those in the former illustration, containing the several selling 
expenses, general and administrative expenses. There is no 
limit to the classification of accounts which can be displayed in 
a well-drafted voucher register. 

The writer well remembers one voucher record which pro- 



404 



FUNDAMENTALS OF ACCOUNTING 



vided space for some one hundred and twenty-eight columns, 
used by a moving picture producer to keep the cost of pro- 
ducing films. The book itself when closed was only three feet 
wide, but when opened was six feet from end to end. A yard 
stick was used to be certain that the debit distribution was 
being made on the same line on the extreme right as the accounts 
payable total appeared on the extreme left. Each single page 
had thirty-two columns, and in order to provide sufficient col- 
umns for the expense distribution desired, a fly leaf with thirty- 
two columns front and thirty-two back was provided, making in 
all some one hundred and twenty-eight columns available. The 
several expenses the producers were interested in keeping sep- 
arate were each given column headings, such as " Stars' Sala- 
ries/' " Extra Help/ 7 " Directors 7 Salaries/ 7 " Camera Men/' 
" Electricians/' " Stage Carpenters/' " Scenery Decorators." 
These are just a few of the salary accounts maintained, and they 
were followed by a long series of other interesting titles such as 
" Location Rentals," " Wardrobe Hire/' " Prop Rentals," and 
so forth. The records were kept in such a way that the cost 
of each picture was kept separately, and when the producers 
studied the costs, which frequently ran close to the million dol- 
lar mark, they could see a uniform treatment of every cent ex- 
pended on the different pictures produced. 

Another special form of voucher register is one which com- 
bines the voucher register and the check register somewhat as 
the one which follows : 



Date 
Paid 


Voucher 
Check No. 


Debit 


Credit 


Payee 


Vouchers 
Payable 


Punch. . 
Discount 


Net 
Cash 














S~~^ 


Voucher 
No. 


Vouchers 
Payable 
Credit 


Debit Distribution 


E 

T 
C. 



























The form above combines the voucher register and the check 
register. As each voucher is paid, the payment data on the ex- 
treme left are filled in; and, gradually, as the vouchers are paid, 



THE VOUCHER SYSTEM 



405 



the page is filled out; and usually only the more recent vouchers 
stand out as unpaid. In this manner it is very easy to check 
the unpaid vouchers with the voucher register. The sum of the 
unpaid vouchers should, of course, agree with the balance of the 
Accounts Payable control account in the general ledger, as well 
as with the total of the vouchers in the unpaid voucher file. 

THE JOURNAL VOUCHER 

In large enterprises care must be taken to see that journal 
entries are carefully drawn and properly approved before being 
entered on the books of the organization. To facilitate such a 
procedure, the journal voucher was first introduced. In a sys- 
tem employing journal vouchers, a separate voucher is pre- 
pared for each transaction, necessitating a journal entry such as 
for the issuance of notes payable to creditors, recording receipt 
of notes from customers, where special note journals are not 
in use, as well as for correcting, adjusting, and closing entries. 



JOURNAL VOUCHER ILLUSTRATED 



No. 136 



THE MODERN MANUFACTURING CO. 
JOURNAL VOUCHER 

Date: Jan. 26. 19_ 



Cash 

Interest Expense 

Notes Payable 

To record proceeds of our 60-day note 
No. 1754, discounted this day at the 
National Bank of New Jersey. 



1980 
20 



2000 



00 



Prepared by J.K.L. Approved S.W. Treas. Entered B. G. 



Journal vouchers similar to the preceding one are usually pre- 
pared by a responsible accounting assistant, then passed on to 
some executive for approval, after which they are returned to 
the bookkeeper in charge of the General Journal. In this man- 
ner every journal entry is not only carefully drawn but audited 
and approved before entry, completing a rather necessary step 
in internal check. Since the journal voucher is such a complete 
instrument, containing all necessary information, it is not neces- 



406 FUNDAMENTALS OF ACCOUNTING 

sary to record explanation, or other detail, in the journal. The 
exact procedure varies with different organizations. Some 
merely enter only the date and the journal voucher number, as 
an explanation of the entry. The postings may be made either 
from the journal voucher or from the journal itself. The sum- 
mary postings to the control accounts will be made as usual 
from the journal. 

ADVANTAGES OF THE VOUCHER SYSTEM 

It is not to be concluded from the foregoing discussion of the 
voucher system that such a system is ideal for all business. 
Small sole proprietary businesses, where the owner maintains a 
close supervision of the management, do not require an elaborate 
voucher system. Nor is it to be inferred that all big business 
will benefit by the installation of the voucher system. Not 
every organization is adapted to the use of the voucher system. 
A concern large or small may not be able to pay its accounts 
promptly, but must continuously resort to extension of time for 
payments, or give notes frequently in settlement of accounts, or 
pay accounts in installments. All of this will require cancella- 
tion of old vouchers and writing new vouchers, and sometimes 
canceling the second voucher when it becomes due, and issuing 
one or two new vouchers to take its place. Under such cir- 
cumstances, a voucher system may hinder rather than help in 
the efficient management and operation of the accounts. 

When properly installed, to meet the needs of the larger or- 
ganizations, where finances and personnel are suitable for its 
introduction, certain very decided advantages accrue to the use 
of the voucher system, some of which are: 

1. It provides for a systematic recording and approval of all in- 
voices, bills, and other items requiring the disbursement of cash. 

2. By the use of voucher checks unquestionable receipts are ob- 
tained for the payment of definite items. 

3. It provides one book in which all purchases of merchandise, 
services, and expense items are recorded, thus combining at least two 
journals. 

4. Not only are time and space saved by the elimination of the ac- 
counts payable ledger, but the accounts usually are maintained in a 
more flexible manner. 

5. By the proper use of the Unpaid Vouchers file, all unpaid vouch- 
ers may be filed in order of date, which payment should be made to 



THE VOUCHER SYSTEM 407 

permit the deduction of cash discounts. Such a practice will facilitate 
the taking of all proper cash discounts. 

6. The voucher system, when properly operated, records immedi- 
ately all current liabilities. Such a procedure is a decided improve- 
ment over the common practice of not recording bills for services and 
expenses until such time as they are paid. 

7. The cash disbursements book used in conjunction with the 
voucher register is greatly simplified, resulting also in a saving of time 
and labor in its operation. 

8. The vouching and approval of all charges and payments is a de- 
cided aid in a system of internal audit and control. 



QUESTIONS ON THE CHAPTER 

1. Define a voucher, a voucher register. 

2. Describe the operations of the voucher register in particular 
regard to: 

(a) How a purchase is recorded. 

(b) When an invoice should be entered. 

(c) Treatment of services such as pay-roll. 

(d) The use of debit extension columns. 

3. Describe the use and operation of the Sundries account and 
money columns. 

4. Explain the summary posting from the voucher register. 

5. Draw a typical voucher jacket and explain its use. 

6. Explain the procedure required if an account, when first re- 
corded, is to be paid in three installments one month apart. 

7. How should a voucher payable currently be treated if an agree- 
ment is reached with the creditor to permit payment in two subsequent 
installments? Explain the entire procedure. 

8. Draft a voucher register for a manufacturing company with 
about twelve money columns and explain its use. 

9. Explain the procedure required for handling purchase returns 
or allowances in the voucher system. 

10. Explain three decided advantages accruing to the use of the 
voucher system. 

1 1 . Explain the function and use of the unpaid and paid vouchers 
files. 

12. Describe two conditions under which you would not recom- 
mend the introduction of a voucher system. Explain why not. 

13. What is a Journal Voucher? Illustrate and explain its use. 

14. Describe the use and the function of the Accounts Payable 
Controlling account or Vouchers Payable Controlling account, as it 
is sometimes called in the modern voucher system. 

15. What two checks are there on the balance of the Accounts Pay- 
able Controlling account, when used in the voucher system? 



408 FUNDAMENTALS OF ACCOUNTING 



PROBLEM MATERIAL 

PROBLEM i 

F. Adams has conducted a boat-building establishment for several 
years, and has just had a new accounting system installed. Part of 
the new system is a " Voucher Register/' with the following layout: 
Vo. No.; Date; Account Credit; Vouchers Payable Cr.; Materials 
Purchases Dr.; Freight Inward Dr.; Direct Labor Dr.; Indirect La- 
bor Dr.; Electric Power Dr.; Indirect Materials Dr.; Sales Salaries 
Dr.; General Salaries Dr.; Advertising Dr.; Delivery Expense Dr.; 
Repairs and Maintenance Dr.; Insurance Factory Dr.; Insurance 
General Dr.; Office Expense Dr.; General Expense Dr.; Sundry 
Accounts Cr.; Sundry Accounts Dr. Another new book is the " Check 
Register," with the following layout: Date; Payee; Voucher No.; 
Check No.; Vouchers Payable Dr.; Purchase Discounts Cr.; and 
Net Cash Cr. 

Using a twelve-column work sheet, lay out the Voucher Register, 
and enter the following selected transactions: 
November 2 Vo. No. i. 

Received an invoice from Reed Book Store, total $128.00, which 
represents the purchase of general office supplies and stationery 
and is to be charged as " Office Expense." 
November j Vo. No. 2. 

A light and power bill from the Public Service Electric Co. for 
$168.00; this is to be charged Electric Power $142.00 and Gen- 
eral Expense $26.00. 
November 5 Vo. No. j. 

A bill for advertising from the Home News Publishing Company 

total $60.00. 
November 6 Vo. No. 4. 

A shipment of lumber arrived from the Portland Lumber Company 

total of $1200.00; this is to be charged as Materials Purchases. 
November 6 Vo. No. 5. 

The Pennsylvania R. R. freight bill on the above-mentioned ship- 
ment is received total $66.40. 
November 7 Vo. No. 6. 

Draw pay-roll, $210.00 for Direct Labor, $60.00 for Indirect La- 
bor, Sales Salaries $84.00, and General Salaries $100.00. 
November 8 Vo. No. 7. 

An Invoice from the Trenton Hardware Co. total $292.00, of which 
$228.00 represents Materials Purchases, and $64.00 Indirect 
Materials. 
November g Vo. No. 8. 

A bill from the Nelson Oram Insurance Agency is received for 
$356.00; this is to be charged $240.00 to Factory Insurance and 
$i 1 6.00 to General Insurance. 



THE VOUCHER SYSTEM 409 

November TO Vo. No. 9. 

An invoice from the General Machine Co., for a new machine de- 
livered and installed $910.00 and chargeable to Machinery and 
Equipment. 
November n Vo. No. 10. 

A bill from the Middlesex Transportation Co. for services to date 

$144.00, all to be charged as a Delivery Expense/' 
November 12 Vo. No. n. 

A bill from the Rapid Repair Service $40.00 to be charged as Re- 
pairs and Maintenance. 
November 13 Vo. No. 12. 

A new delivery truck was purchased from W. E. Mount and Co. for 

a total delivered price of $1345.00. 
November 14 Vo. No. i j. 

Payroll total $469.00; charge Direct Labor $216.00, Indirect Labor 

$69.00, Sales Salaries $84.00 and General Salaries $100.00. 
November 15 Vo. No. 14. 

An invoice and shipment from the Basic Metals Co., Inc., total 
$265.60, chargeable $205.00 as Direct Materials, $11.60 as 
Freight Inward, and $49.00 as Indirect Materials. 

Required: 

(1) Using a twelve-column work sheet, rule the top half as the left 
page of a voucher register and head in columns from left to 
right as indicated above; and on the lower half of the same 
work sheet, rule in headings for the balance of the columns, 
indicating this lower half as the right-hand page of a double- 
spread book. Allow for fourteen vouchers. 

(2 ) Enter the fourteen vouchers and foot all columns. Cross check 
the individual totals of the debit columns with the total of the 
Vouchers Payable column. 

PROBLEM 2 

Open a check register similar to the form used in the text, having 
the following layout: Date; Payee; Vo. No.; Check No.; Vouchers 
Payable Dr.; Purchase Discounts Cr.; and Net Cash Cr. 

Assume that on November 15, Voucher 4 is paid less a 2% dis- 
count; Voucher 6 is paid net November 16; Voucher n is paid No- 
vember 1 8 without discount; Voucher 8 is paid November 18 less 2% 
discount; Voucher 13 is paid November 24. 

Required: Draft a check register as indicated and enter the payments 
given above. Total and prove the columns. 



CHAPTER XXII 

PAYROLL ACCOUNTING AND THE SOCIAL 
SECURITY PROGRAM 

INTRODUCTION 

Another branch of the accounting department which requires 
good records and an adequate system of control is the Payroll 
Division. Happily, good accounting has always required good 
records in this important division of the accounting department. 
The passage of the Federal and State social security laws, how- 
ever, has made the maintenance of good records in this depart- 
ment almost imperative. 

SOCIAL SECURITY LAWS 

It is not our purpose to give here a complete treatise on the 
social security laws, but rather to emphasize the sections and 
parts which have a direct bearing upon the proper accounting 
for wages and salaries paid.* 

With this purpose in mind, we shall discuss briefly the most 
important phases of the act. The Social Security Act was ap- 
proved by the President and became a law August 14, 1935. 
Since that time the constitutionality of the tax provisions of the 
Act have been upheld by the United States Supreme Court. The 
purpose of the Act in brief might be stated as follows : To pro- 
vide grants to States for old-age assistance, unemployment com- 
pensation administration, aid to dependent children, maternal 
and child welfare, public health work, and aid to the blind. 
These grants are made direct to the States, and the individual 
receives the benefits thereof under his State law. A second and 

* A copy of the Act and its amendments may be had from the offices of the 
Social Security Board, or from the United States Government Printing Office, 
Washington, D. C. 

A good exposition of Social Security Taxes is included in the Alexander Fed- 
eral Tax Course and Guide, published by the Alexander Publishing Company, 
Inc., New York. 

Another complete discussion of social security accounting is contained in the 
Pathfinder course in Social Security Accounting, published by the Charles R. 
Hadley Company, of Los Angeles, California. 

The author is indebted to both of these latter sources, as well as to the act 
itself, for much of the material included in this chapter. 

410 



SOCIAL SECURITY ACCOUNTING 411 

most important purpose of the Act provides for Federal old-age 
benefits. The only taxing provisions of the Act are contained 
in the Federal old-age pension tax and the Federal unemploy- 
ment tax, and these will be discussed in more detail. 



FEDERAL OLD-AGE AND SURVIVORS INSURANCE TAX 

This part of the Social Security program will be discussed 
first. Title II of the Act provides for certain old-age and sur- 
vivors benefits to be paid by the Federal government direct to 
the beneficiaries. It is strictly a Federal program administered 
by the Federal government without State aid. For support of 
these benefits there is imposed a Federal tax on both employers 
and employees. 

Every employer must pay an excise tax on wages paid to each 
employee up to $3000.00, while the employee pays a similar 
" income " tax on the first $3000.00 of remuneration received. 
This latter tax must be deducted by the employer and is pay- 
able, together with the employer's share, to the Internal Reve- 
nue Department. These taxes are payable quarterly when 
Treasury Department, Internal Revenue service form SS-ia 
must be filed. 

The rate of tax is identical for both employers and employees, 
increasing from one to three per cent as follows: 1937 to 1942 
inclusive, i%] 1943, 1948, and 1945, 2%\ 1946, 1947, and 
1948, 2%%; 1949 and thereafter 3%. 

Thus the first $3000.00 of wages paid to an employee is tax- 
able both to the employee and his employer, and the employer 
must make proper deductions from payrolls and file the 
Treasury Department form with the local collector of internal 
revenue. 

The amount of the old-age insurance tax paid by the employee 
is not an allowable deduction on his Federal income tax return 
because the payment is considered in form of an insurance 
premium for which the employee himself, his wife, children, or 
survivors will receive direct benefits. 

The amount of the old-age insurance tax paid by the em- 
ployer, on the other hand, is considered as a legitimate operat- 
ing expense and as such is deductible on the regular Federal 
income tax return, and on State income tax returns. 



4 i2 FUNDAMENTALS OF ACCOUNTING 

In order to understand better the operations of the Act a few 
definitions are given herewith in brief. 

Employer. Any person (including corporations, partnerships, 
etc.) who employs one or more individuals in non-exempt 
employment. 

Covered Employment. After December 31, 1939 covered em- 
ployment which subjects both employer and employee to tax 
includes all services performed within the United States with 
certain exceptions, which are briefly the following: 

1 i ) Agricultural Labor. 

(2) Domestic Service. 

(3) Casual Labor. 

(4) Family Employment. 

( 5 ) Service on foreign vessels. 

(6) Federal government Service. 

( 7 ) State and local government service. 

(8) Service for religious, charitable, and similar organizations. 

(9) Service for rail carriers. (They have their own act.) 
(10) Service for miscellaneous non-profit organizations, 
(n) Service for a foreign government. 

(12) Service for a foreign government instrumentality. 

( 13 ) Service of student nurses and internes. 

(14) Service of fishermen, etc. 

(15) Service in newspaper distribution, if under 18. 

Employee. Every individual is an employee if he is engaged 
in covered employment. 

Independent Contractors. The facts in each case must be 
considered in determining whether or not one is an independent 
contractor and therefore not subject to a tax as an employee. 
Physicians, lawyers, public accountants, dentists, architects, 
engineers, and others who follow an independent trade, busi- 
ness, or profession in which they offer their services to the 
public, generally are considered independent contractors and 
not employees. 



IDENTIFICATION 

Employers and employees must both be identified by social 
security numbers. An employer receives an " identification " 
number, while the employee receives an " account " number. 



SOCIAL SECURITY ACCOUNTING 413 

TAX AND INFORMATION RETURNS 

Employee Tax. The employer is required by law to with- 
hold the employee's old-age insurance tax from wages paid. 
These funds are held in trust for the Treasury of the United 
States, and cannot be attached by legal process by a creditor. 
A separate liability account should be opened in the general 
ledger to show the balance of this trust fund due at all times to 
the Federal Government. 

STATEMENTS TO EMPLOYEES FOR WAGES PAID AND 
TAX DEDUCTIONS 

Section 1403 of the Federal Insurance Contributions Act pro- 
vides in brief that every employer must furnish each employee 
with a statement showing wages paid, and the deductions for 
tax. Failure to furnish such a statement is punishable by fine. 
Most business organizations to meet this requirement give a 
statement every pay day. This statement may take the form 
of a pay check voucher, a pay envelope, or a payroll voucher, 
each of which will be illustrated and discussed later in this 
chapter. 

Employer Tax. In addition to the liability account for the tax 
which the employer withholds from the wages of the employees, 
he should provide an account for his own tax. The amount of 
both taxes, as previously explained, is payable to the Internal 
Revenue Department quarterly. 

STATE UNEMPLOYMENT TAXES 

Title III of the Social Security Act treats the subject of un- 
employment compensation. The Federal Government does not 
provide direct unemployment compensation benefits to em- 
ployees, but it encourages the States to establish and administer 
their own unemployment compensation systems. To those 
States which meet the requirements of the Act the Federal gov- 
ernment assists with outright grants to aid in the administra- 
tion of the laws. Every State, Alaska, Hawaii, and the District 
of Columbia have enacted unemployment compensation laws, 
which follow the Federal Act, and have therefore been approved 
by the Social Security Board. 



4 i4 FUNDAMENTALS OF ACCOUNTING 



EMPLOYERS' TAX 



The Federal unemployment tax specifically provides that the 
tax levied by it on employers of eight or more is to be collected 
by the Internal Revenue Bureau under the direction of the Sec- 
retary of the Treasury and is to be paid into the Treasury of the 
United States as internal revenue collections. Each employer 
is required to make a return not later than January 31 next fol- 
lowing the close of the taxable year. After 1939, the Federal 
unemployment compensation tax is based upon the first 
$3000.00 of wages paid in covered employment, as in the case 
of the old-age insurance taxes. 

The amount of this tax is 3 per cent of the wages paid or pay- 
able to employees. The employer may, however, credit his con- 
tributions to the State employment funds against this Federal 
tax, equal to, but not in excess of, 90 per cent of the Federal tax. 
Most State laws, therefore, provide for a tax levy on employers 
of 2 .7 per cent, which amounts to 90 per cent of the Federal tax. 
In brief, therefore, the employer pays only a total of 3 per cent 
of taxable wages 90 per cent to the State fund and 10 per 
cent to the Federal Government. For example, if the taxable 
payroll of a company were $10,000.00, the Federal tax would 
be 3 per cent or $300.00. If the State tax is 2.7 per cent, then 
the company pays the State $270,00, exactly 90 per cent of the 
$300.00 and the amount payable to the Federal Government 
would be just $30.00. 

MERIT RATINGS 

As there are fifty-one separate State and territorial unem- 
ployment compensation laws, each with its own provisions, 
peculiarities, and special features, we shall not attempt any 
further study of the State laws except as they effect the so-called 
" merit ratings." One of the major purposes of the State law 
is to stabilize employment, and in support of this purpose most 
States have set up certain merit ratings to employers who meet 
their standards. These standards are set forth in the Federal 
Unemployment Tax Act. Good management would also favor 
a low labor turnover; it will be to the interest of the manage- 
ment, therefore, to study carefully the laws the State or States 
involved relative to the merit ratings. 



SOCIAL SECURITY ACCOUNTING 415 

Under the merit ratings plans now in use in most States, there 
is maintained for each employer a separate account to show as 
credits all the payments made by the employer and all the debits 
for benefits paid to his employees. Employers with a favorable 
record are taxed at a lower rate. In most States, when the bal- 
ance in an employer's account reaches 7 per cent, the tax is 
reduced; the reductions become greater as the balances be- 
come larger. These lower rates would result in no advantage 
to employers if only actual payments to State funds were al- 
lowed as credits against the Federal tax, for a lower State tax 
would mean only a higher Federal tax. To avoid this result, an 
additional credit is allowed. The Social Security Act provides 
that, where such merit rating provisions are established, full 
recognition will be given such rates by means of additional 
credits. Briefly, if the normal State tax rate is 2.7 per cent and 
an employer -is allowed a merit rating, and required to pay only 
1.8 per cent, he will be allowed a credit against the Federal tax 
for the amounts actually paid the State at 1.8 per cent, and in 
addition the .9 per cent merit deduction. In effect, the employer 
will receive the full credit of 2.7 per cent which is the maximum 
allowed, just as if he had paid the full State tax. The merit 
rating provisions of every State law now in effect comply with 
the Federal requirements. 



THE WAGE AND HOUR LAW 

The Wage and Hour Law, more officially the Fair Labor 
Standards Act of 1938, was approved on June 25, 1938, and be- 
came effective the following October 24th. Under this law a 
subject employer is one engaged in interstate commerce or in 
the production of goods for interstate commerce, or whose pro- 
duction substantially affects the flow of interstate commerce. 
All employment in such commerce or production is subject to 
both wage and hour provisions of the law, except professional 
men, seamen, those engaged in fishing or agriculture, or within 
the area of production, learners, apprentices, and handicapped 
workers. There are other exemptions for local newspapers, 
carriers by air, and street and suburban railways. The hour 
provisions do not apply to any employee of an employer subject 



416 FUNDAMENTALS OF ACCOUNTING 

to section 204 of the Motor Carrier Act of 1935 or to Part I of 
the Interstate Commerce Act. 

As in the Social Security Act, wages include the reasonable 
cost to the employer of furnishing the employee with board, 
lodging, etc., if customarily furnished. No tax is involved, but 
maximum hours and minimum rates of pay are prescribed. 



RECORD-KEEPING REQUIREMENTS 

Neither the Federal nor State acts require any particular sys- 
tem of accounts or records. It is required, however, that each 
employer keep a true and accurate record of all his workers, the 
wages paid by him to each worker, and such other information 
as the administrative body may require. 

The various States have released regulations concerning the 
keeping of the payroll. A composite listing of the more im- 
portant requirements includes: 

1 . The period covered by the payroll. 

2. The place of employment within the State. 

3. The scheduled hours per day or week. 

4. The total of taxable earnings for all employees during each pay 
period. 

For payroll record-keeping it is necessary to keep the follow- 
ing information in respect to each employee : 

1. Employee's name and address. 

2. Date of birth. 

3. Social security account number. 

4. Occupation and sex. 

5. Point of hire and point of employment. 

6. Date of hire. 

7. Regular rate and basis of pay. 

8. Hours worked each work day and each work week. 

9. Week's wages at regular rate of pay. 

10. Overtime wages, if any. 

1 1 . Additions or deductions from cash wages identified. 

12. Total taxable wages and date of employment. 

13. Date of separation from payroll and reason therefor. 

It will thus be seen that, while no particular system of ac- 
counts is prescribed, the Federal and State governments require 
good, accurate records, and the employer is subject to penalties 



SOCIAL SECURITY ACCOUNTING 417 

if he does not keep appropriate records. These records must 
be open for inspection by authorized State or Federal repre- 
sentatives. 



SUGGESTED FORMS AND RECORDS 

At this point it might be well to suggest some forms essential 
or helpful in keeping records which will not only conform with 
all the new laws, but meet the requirements of all good account- 
ings as well. 

EMPLOYMENT RECORD 

All form-printing agencies have standard ruled cards or paper 
forms designed to display the information required for all pur- 
poses of the Social Security laws, regarding employee informa- 
tion. The bookkeeping and tabulating machine companies have 
for sale or will recommend forms which fit their particular 
machines. Several accountants have prepared Social Security 
" Sets " for the small company. These sets provide all forms 
required: Employment records, payroll forms, etc., with direc- 
tions for their use. 

No particular forms for employment records are therefore 
illustrated, but, regardless of the source of the form, it should 
contain the following information: 

1. Employee's full name, address, and social security account 
number. 

2. Date and place of birth, sex and occupation. 

3. Dependents and other pertinent information, including educa- 
tion and previous employment. 

4. Wage rate, basis of pay and starting date. 

5. Departmental or clock number. 

6. Position changes, advancement. 

7. Accidents. 

8. Reason for leaving. 

9. Signature of employee. 

PAYROLL FORMS 

Here again all the bookkeeping and tabulating machine com- 
panies have forms designed to fit their particular equipment. 
There are, of course, many business organizations which have 
not this type of equipment and which must rely upon hand- 



4i8 FUNDAMENTALS OF ACCOUNTING 

written records. The standard form companies, however, have 
again come to the aid of these smaller companies and have 
printed some very good payroll forms. The illustration oppo- 
site is presented simply as an idea of what such a form should 
look like, and to act as a basis for a short discussion on how 
this phase of the work is carried out. 

This form is used for each department, and needs very little, 
if any, explanation. The deductions are first for Federal old- 
age benefits, and amount to one per cent of the total wages 
earned. Some organizations make other deductions for the 
convenience of the employee, as the community chest deduc- 
tions illustrated above, or deduct insurance premiums for com- 
pany group insurance. In a few States there is a deduction 
made for the employees' payment to the State unemployment 
fund; such a deduction could, of course, be entered next to the 
Federal Old-age Benefits deduction, before the other miscel- 
laneous deductions are listed. The last money column is the 
amount due the worker, for which a payroll check will be drawn. 

PAYROLL CHECK 

A voucher check will best meet the needs of the social security 
program. The illustration on page 420 shows a pay check with 
a detachable voucher. This voucher will serve as a proper em- 
ployee statement in conformity with the law. There are other 
ways of giving this information to the employee. One is by fill- 
ing in a pay envelope especially printed with the same informa- 
tion as the payroll voucher, illustrated on page 420, attached to 
the payroll check. An envelope would be used if the men were 
paid in cash, as this would be the easier form of statement and 
receipt. 

ACCOUNTS REQUIRED 

It will be necessary to establish several expense accounts and 
several liability accounts to record properly transactions pe- 
culiar to the social security program. The following are sug- 
gested, together with a brief explanation of their function 
and use. 

i. " Old-age and Survivors Insurance Tax." This expense 
account will be used to record the amount of the employer's pay- 
roll tax. It will be debited each pay day with i % of the total 



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SOCIAL SECURITY ACCOUNTING 421 

taxable payroll and at the same time the corresponding liability 
account " Employers' Old-age and Survivors Insurance Tax 
Payable " will be credited. The expense account will be closed 
at the end of the accounting period with all other operating ex- 
pense accounts. 

2. " Federal Unemployment Compensation Tax." This ex- 
pense account will be used to record the employer's tax for 
Federal unemployment. The total tax payable on the affected 
payroll for the year is usually .3%. The Federal tax is 3%, 
but a 90% credit is allowed for contributions made to the State 
Unemployment Fund, which is 2.7%, leaving only .3% on the 
affected wages. The corresponding credit is to " Federal Un- 
employment Compensation Tax Payable " account. 

3. " State Unemployment Compensation Tax." This ac- 
count is used to record the employee's tax paid to the State Un- 
employment Fund mentioned above. The debit is made for 
taxes due the State, which is based on wages paid, and taxed at 
2.7%, except where a merit rating is in effect which will lower 
this rate. The credit made at the same time is to a correspond- 
ing liability account " State Unemployment Compensation Tax 
Payable." 

4. In addition to the three liability accounts mentioned in 
conjunction with the three expense accounts above, it will be 
necessary to open one other liability account to represent the 
employer's liability for employees' deductions. This account, 
" Employees' Old-age and Survivors Tax Payable " should be 
credited with the total of the payroll deductions made each pay 
day. It will measure the company's liability to pay this sum 
to the Federal Government. 

DEMONSTRATION CASE 

Suppose the X Company payroll for the week of December 
26, 1940 is as follows: 

Factory Payroll $1000.00 

General Salaries 500.00 

In this illustration, in order to simplify matters, we shall as- 
sume that the entire payroll is subject to tax (no one receiving 
more than $3000.00 per year). This payroll then will be sub- 
ject to: (i) A i% deduction for the Federal Old-age and Sur- 



422 FUNDAMENTALS OF ACCOUNTING 

vivors Insurance Tax, which amounts to $15.00; (2) A Federal 
Unemployment Compensation Tax of .3%, which amounts to 
$4.50; and (3) A State Unemployment Compensation Tax of 
2.7%, which amounts to $40.50. 

In order to see most clearly the entries required we shall make 
use of the general journal, giving a complete explanation of 
each entry. 

GENERAL JOURNAL 

-i- 
Factory Payroll ................ $1000.00 

General Salaries ................ 500.00 

Vouchers payable ............. $1485.00 

Employees' Old-age Tax Payable 15.00 

To record the payroll for the week 
of December 26, 1940. 

(The entry above would appear in the voucher register.) 
(The following entry would be written in the cash disburse- 
ments book.) 

-2- 

Vouchers Payable .............. $1485.00 

Cash ....................... $1485.00 

To record payment of payroll De- 
cember 26, 1940. 

(The following entry should also be written in the general 
journal to record the proper liability.) 



Old-age Security Tax .............. $15.00 

Federal Unemployment Comp. Tax . . 4.50 
State Unemployment Comp. Tax .... 40.50 

Employer's Old-age Tax Payable . . $15.00 

Federal Unemployment Comp. Tax 

Payable .................... 4.50 

Employer's State Unemployment 

Tax Payable ................. 40.50 

To record the liability and expense in- 

cident to the pay-roll of December 26, 

1940. 

Calculated as follows: Employers i% of $1500.00 for Old-age 

Tax; .3% of $1500.00 for Federal Unemployment; 2.7% of 

$1500.00 for State Unemployment Tax. 



SOCIAL SECURITY ACCOUNTING 423 

At the end of the year or quarterly, as vouchers are prepared 
and payment made for the State and Federal Social Security 
Taxes, each accrued tax payable account should be debited, and 
vouchers payable credited, in the voucher register. This entry 
to be followed by one in the cash disbursements book, debiting 
vouchers payable and crediting Cash. 



QUESTIONS ON THE CHAPTER 

1. What are the two principal divisions of the Social Security 
laws? 

2. (a) Give the important tax provisions of the Old-age Insur- 
ance section, (b) Who is taxed for this insurance? (c) How much? 

3. What is the nature of the two taxes paid by the employer? 

4. Is the tax paid by the employer deductible from his Federal 
and State income tax report? 

5. Is the deduction made from an employer's wage an allowable 
deduction on his Federal or State tax return? 

6. Suggest the information you should like to see kept on an em- 
ployer's record. 

7. What specific records must be kept to comply with the several 
social security acts? 

8. Explain merit ratings, giving consideration to the following: 
(0) The purpose, (b) How they are arrived at. (r) The result in 
favor of the employer. 

9. In connection with the Federal Unemployment Compensation 
law, explain the following: (a) Employer, (b) Employee, (c) Cov- 
ered employment. 

10. Explain the relation of the State Unemployment tax to the tax 
paid to the Federal Government for Unemployment. 



PROBLEM MATERIAL 

i. Draw a payroll form for the Modern Manufacturing Company 
and enter the following information: Period week ended January u. 
T. Tyler, 36 hours, $.42 per hour; B. Mack, 40 hours, $.45 per hour; 
C. Clyde, 40 hours, $.50 per hour; J. Thomas, 36 hours, $.60 per 
hour; J. Wallace, 40 hours, $.60 per hour. Furnish social security 
and clock numbers for each employee. Deductions for old-age bene- 
fits are i%. In addition $.50 is deducted from the following for Com- 
munity chest pledges: Clyde, Thomas, and Wallace. 

Required: 

(1) Rule the form which will best display the information. 

( 2 ) Enter the payroll. 

(3) Total all columns. 



424 FUNDAMENTALS OF ACCOUNTING 

2. Draw a payroll check for Mr. C. Clyde, with a voucher at- 
tached. 

3. Assume the following: The payroll for the week ended January 
1 8, 1941 is as follows: 

Factory payroll $3600.00 

General office 1400.00 

Salesmen's salaries 1200.00 

Assume all salaries are taxable. 

Required: Write in journal entry form: 

(1 ) Journal entry to record the payroll in the voucher register. 

(2) Journal entry when the payroll is paid through the cash dis- 
bursements book. 

(3) General journal entry to show the proper liability. 

4. Assume the annual payroll of the Maxim Manufacturing Com- 
pany amounts to $18,000.00 before deductions and all subject to tax. 

The State unemployment tax is 2.7% for employees. 

Required: 

1 i ) Federal Old-age Tax. 

(2 ) Federal Unemployment Compensation Tax. 

(3 ) State Unemployment Compensation Tax. 

(4) Journal entries to voucher the pay roll. 

(5) Journal entry for payment through the cash disbursement box. 

(6) General journal entry to record liability to the Federal and 
State governments. 

( 7 ) Entry to record the payment to the Federal and State govern- 
ments. 



CHAPTER XXIII 

ANALYSIS AND INTERPRETATION OF FINANCIAL 

STATEMENTS 

INTRODUCTION 

In our opening chapters the student was first presented with 
an introduction to financial statements. The purpose then was 
to acquaint him with the fundamental make-up of these state- 
ments, so that he would have a foundation for the work which 
followed. The next few chapters presented the bookkeeping 
cycle, including the operation of a complete set of double-entry 
books. This material was followed by a study of the account- 
ing work required at the close of the accounting period, includ- 
ing a study of adjustments, work sheets, and closing the books 
and the preparation of financial statements. Then followed a 
study of the accounting problems presented by the partnership, 
the corporation, and the manufacturer. All of this work may 
properly be classed as constructive accounting, and is necessary 
so that the student would have a good foundation in theory and 
practice. It is our purpose now to present once more the bal- 
ance sheet and profit and loss statement, but this time, however, 
with a view of analytical interpretation. 

MANAGEMENT'S USE OF FINANCIAL STATEMENTS 

Statements are prepared, of course, for many users. Credit- 
grantors, banks, and investors all study financial statements and 
each may be looking at the statement with his particular prob- 
lem in view. While we are interested in all these groups and 
shall include the viewpoints of some of them, for the most part 
we shall have in mind the need of the business management in 
operating its own business. 

The accounting department will, of course, prepare the state- 
ments, and it often becomes the duty of the chief accountant 
or controller to explain and interpret the financial statements 
to the management. This work is often done under the guid- 
ance and supervision of a Certified Public Accountant. With 
this in mind, the controller or public accountant will be inter- 
ns 



426 FUNDAMENTALS OF ACCOUNTING 

ested in seeing not only that the accounting system is adequate, 
but that its operation will yield statements which will facilitate 
his work. 

OTHER USERS OF FINANCIAL STATEMENTS 

A financial statement prepared for use by the management or 
owners of the company would, of course, be entirely satisfactory 
for the banker or the creditors. The banker or the creditors 
will not, ordinarily, have presented to them all the detail avail- 
able to the management. A balance sheet or profit and loss 
statement prepared for publication is usually in a much more 
condensed form than that prepared for the management. 
Many published balance sheets are therefore useless for study, 
and an interested person will often have to ask for supplemen- 
tary information, or even a more detailed and complete finan- 
cial statement. 

Banks and credit departments, however, usually keep a com- 
plete file for each of their customers, and make their own use of 
this material us an aid in analysis and interpretation. Pro- 
spective purchasers of a business, too, may wish to study a com- 
pany's financial statements, and may wish very complete detail; 
often they employ their own certified public accountants and 
attorneys in order to see that they are made aware of a full and 
complete as well as correct set of reports before they are willing 
to invest their capital. Then, too, the Government is an inter- 
ested party, because of the income tax angle. The Federal 
Government, and frequently the State, will wish to know a great 
deal about each taxpayer. Officials viewing the material pre- 
sented on their forms will often request supplementary data, 
particularly if the report as filed seems inadequate for their 
purpose. 

There are other reasons which will prompt the preparation of 
balance sheets, as in the case of a bankrupt organization. In 
this instance an entirely different set of values may be ascribed 
to the assets, because the trustees or receiver in bankruptcy 
will probably wish to know, besides the book amount of the 
assets, the amount which the assets will bring under the peculiar 
conditions of bankruptcy sale. The purpose for which a state- 
ment is to be used must, therefore, be kept in mind as the state- 
ment is prepared. At what value should an asset such as De- 



ANALYSIS OF FINANCIAL STATEMENTS 427 

livery Equipment be listed on the balance sheet? Certainly a 
higher valuation is justifiable for a going concern than the value 
which should be ascribed if the balance sheet is being prepared 
for a concern winding up its affairs, as in bankruptcy. 

In our present study, however, we shall concern ourselves 
only with the analysis and the interpretation of financial state- 
ments for a going concern. 



THE PROBLEM OF ANALYSIS AND INTERPRETATION 

A. The Balance Shccet. The principal problem in the study 
of a balance sheet, it would seem, would be largely one of valu- 
ation. The problem of valuation of assets on the balance sheet 
is very intimately connected with the interpretation of the state- 
ment. As the banker reads a balance sheet, he is trying to in- 
terpret the concern's true financial position. In doing this he 
very carefully studies the amounts ascribed to the assets listed. 
As the business man reads his own balance sheet, he looks at 
valuations as an aid in understanding his true position. We 
can, therefore, conclude that the problem is largely one of proper 
valuation. 

B. The Profit and Loss Statement. This statement is of vital 
interest to all concerned, because it reviews the activities of the 
organization over a period of time. To be of value it must, of 
course, contain a full disclosure of all expense and income for 
the period. In order that the reader may get a good picture of 
the operation of the period under review, the profit and loss 
statement should show as much detail as possible. 

C. Need for a Study oj Both Statements for Accurate Analysis 
of Financial Condition. Not many years ago the balance 
sheet was considered by many accountants, bankers, and credit 
men as the principal financial statement; often a credit analysis 
could be based largely, if not entirely, on a study of the balance 
sheet. The statement of income, profit, and loss was certainly 
given only secondary consideration. Many bankers would 
grant a loan simply based on a satisfactory balance sheet, but 
those days have gone forever. Today the banker not only 
wishes to see the current balance sheet of a prospective bor- 
rower, but he wants usually the past four or five in addition. 
Similarly, he will request the past five profit and loss statements. 



428 FUNDAMENTALS OF ACCOUNTING 

From these statements he can get a good idea of what has hap- 
pened in the past, and up to the date of the loan application. 
But even this will not always satisfy him. Quite frequently the 
banker will request the purpose of the loan, and he will have a 
lot to say regarding this aspect of the transaction. This still 
does not complete his study; very often he will request a report 
of estimated income and expense, probable receipts and dis- 
bursements, for the next year, including, of course, a payment to 
him as amortization of the loan as per agreement. 

The banker studies all these reports together not any one 
of them alone will do and only after a careful study of these 
several statements will a decision be made. 



PROPER CLASSIFICATION OF ACCOUNTS AS AN AID 
IN ANALYSIS 

The accounting department can aid a great deal in this prob- 
lem. Standardizing accounting terminology and nomenclature 
will help a great deal, because faulty and misleading account 
titles may lead the reader of a balance sheet to a wrong conclu- 
sion. Another help in the solution of this most important prob- 
lem is the use of standard forms for both the balance sheet and 
the profit and loss statement. If one order of presentation is 
followed one month, then the same order should be followed 
the next month if intelligent interpretations are to be made. 
Standard treatment of certain accounts should be established, 
and, once established, should not be varied except for good 
reason. For instance, in the matter of Freight and Express 
Charges, or Purchase and Sales Discounts, there may be dual 
theory as to how these items should appear on the profit and 
loss statement; but, once the problem is settled for a particu- 
lar organization, then they should always appear in the same 
place, and so on with account after account. 

The use of standard forms and of uniform accounting is 
greatly facilitated by a classification of accounts. Even the 
smallest business will benefit by a good classification of ac- 
counts, and the advantages are even greater for large organ- 
izations. 

There are several classifications in use, and to set up arbi- 
trarily any classification as superior to all others would be going 



ANALYSIS OF FINANCIAL STATEMENTS 429 

a little too far in standardization. The individual business and 
its particular problems must be studied before any classification 
is decided upon. The student at this time should review Chap- 
ter IV and reread the suggested classification of accounts given 
there. 

ANALYSIS TECHNIQUE 

Almost every analyst will have a technique of his own, but 
some of the basic forms and methods of procedure are common 
to all good analysts. Several elementary forms illustrating 
method and technique, together with some of the observations, 
will now be presented. As we are interested primarily in prin- 
ciples, our illustrations are purposely simplified. 

CASE I : THE BALANCE SHEET 

A method used widely by analysts is to spread the various 
assets vertically on analysis paper. Usually the most liquid 
assets appear first, cash heading the list, followed by other cur- 
rent assets. This group will be totaled and a space provided for 
ratio markings or other comments. Next, following directly 
below, will appear the other groups of assets, similarly totaled 
and spaced. After the assets have been listed, the liabilities 
will be displayed in a similar manner. Alongside each item on 
the balance sheet will be listed percentage relationship of the 
several items to the group, and another percentage illustrating 
the percentage relationship of the item to the total assets. Other 
percentages or ratios may be worked up to illustrate particular 
information interesting to the individual. 

SOME OBSERVATIONS FROM THE BALANCE SHEET: 
GENERAL STATEMENT 

To interpret a balance sheet properly, one must understand 
that it consists of three major divisions, two of which are 
termed working capital, and fixed assets plant and equipment, 
respectively. The working capital is represented by current 
assets and current liabilities, and its problem of interpretation 
is the probability that the current assets are sufficient to pay the 
current liabilities as they become due, and to pay the cost of 
materials and labor that will be expended in providing addi- 



430 



FUNDAMENTALS OF ACCOUNTING 



ILLUSTRATION OF BALANCE SHEET WITH PERCENTAGES 

THE YORK COMPANY 

Balance Sheet 

ASSETS 
% Current: % 

10.71 Cash $30,000.00 20 

4.29 Notes Receivable 12,000.00 8 

Accounts Receivable . . $ 84,000.00 

Less Reserve 4,000.00 

28.57 80,000.00 53^ 

10.00 Inventories ^28,000.00 

Total Current Assets $150,000.00 100% 

Deferred /lssr/s: 

2.14 Prepaid Advertising 6,000.00 

1.43 Prepaid Insurance 4,000.00 

10,000.00 
Fixed Assets: 

Delivery Equipment . . $ 14,000.00 
3.57 Less Reserve 4,000.00 

10,000.00 8^ 

Buildings 54,000.00 

1 1. 8 Less Reserve __ 14,000.00^ 

40,000.00 33i 

Machinery & Equip. . . 75,000.00 

21.43 Less Reserve 15,000.00 

60,000.00 50 

3.57 Land 10,000.00 8i 

_____ Total Fixed Assets $120,000.00 

JJ? *^?. - Total Assets $280.000.00 100% 

LIABILITIES 

% Current: % 
Notes Payable: 

1.43 Banks $ 4,000.00 5.56 

2.14 Trade Notes 6,000.00 8.33 

21.43 Accounts Payable 60,000.00 83.33 

.71 Salaries & Wages Accrued 2,ooo qp__ 2.78 

Total Current Liabilities $ 72,000.00 100.00 

Fixed Liabilities : 

7.14 Mortgage (on Buildings) 20,000.00 83.33 

1.43 Notes on Delivery Equipment .... 4,000.00 16.67 

Total Fixed Liabilities 24,000.00 

Total Liabilities 96,000.00 100% 

NET WORTH 

Capital Stock Auth. . . $200,000.00 
Less Unissued Stock 80,000.00 

Outstanding Shares 120,000.00 

42.86 (par value $100) 

_22 S6 Surplus: 64,000.00 

100.00 Total Liabilities and Net Worth $280,000.00 



ANALYSIS OF FINANCIAL STATEMENTS 431 

tional materials for sale while the goods on hand at the date 
of the balance sheet are being sold to customers and the cash 
collected therefrom. The problem with the fixed assets is a 
determination of the ability of the enterprise to make suf- 
ficient profit to replace the fixed assets as they become worn 
out without calling upon the stockholders for an additional con- 
tribution of capital; and, in addition, to distribute to the stock- 
holders an adequate compensation in the form of dividends on 
their investment in the enterprise. 

From the illustration opposite we may make many observa- 
tions. The observations will have very little value, however, 
unless compared with something. Some other period, or some 
other company must be used as a basis of comparison, for, taken 
alone, such a study can mean very little. Of course, we 
may make one or two general observations and point out cer- 
tain favorable ratios. The best service from an analytical study 
will come from a study of comparative balance sheets. The 
figures of one year are compared with the figures of another; 
then trends may be studied which will be valuable in guiding the 
management in plotting its course for the next period. At this 
time, however, we shall mention several common observations 
usually made from the Balance Sheet and comment on the rela- 
tive value of each observation, after which we shall present an 
illustration of Comparative Balance Sheets and apply some of 
the theory here presented. 

WORKING CAPITAL 

Without a doubt one of the most important observations to 
be made from a study of the balance sheet is the ratio that exists 
between current assets and current liabilities. This study de- 
termines the working capital. The ability of a concern to meet 
its current obligations as they mature may determine whether 
or not it will remain in business. 

In our illustration the working capital ratio is 2 .08 to i ? which 
indicates that this company has $2.08 worth of current assets 
to meet $1.00 of current liabilities. Ordinarily this would be 
a quite satisfactory ratio. However, before we can say any 
ratio is satisfactory or not there are one or two points of vital 
interest which should be made clear. First, how accurate is 
the ratio? Mathematically perfect; and if our current assets 



432 FUNDAMENTALS OF ACCOUNTING 

are truly current in the real meaning of the term, and the cur- 
rent liabilities are correctly stated then the ratio is very 
satisfactory. 

First, in an actual case we should have to be sure that each 
item listed as a current asset was properly included. Current 
assets should be limited to cash and those items which, in the 
normal course of business, we have a reasonable right to expect 
will be converted into cash in a relatively short time. This 
period may be three months, six months, or even a year, depend- 
ing upon several factors to be decided in each individual case. 
The important point to remember is that, whatever line of limi- 
tation is used on the asset side of the balance sheet to mark off 
current assets, that same division point must be used on the 
liability side. In our case the York Company has $150,000.00 
of current assets, and $72 ,000.00 of current liabilities. Of what 
value would these figures be, if we were to determine that the 
most optimistic view of the current assets would be a conversion 
to cash in six months, while only those items which are imme- 
diately due are listed as current liabilities, but that before six 
months have passed the current liabilities will be doubled? 
However, if we can say that the current assets amount is made 
up of items that we have every reasonable right to believe will 
be converted into cash within six months, and that there would 
be no great increase in the current liabilities for the next six 
months, then this ratio of 2.08 to i would seem to be very 
satisfactory. Current need for funds to carry on the business 
must be anticipated. Payments on the already existing liabili- 
ties must be made, and the current expenses such as payrolls 
must be met. Therefore, unless there is a good excess of cur- 
rent assets over current liabilities, the concern is likely to be 
financially embarrassed. There is no such thing, however, as 
a standard ratio. The ratio which exists must be studied in 
the light of all facts as they exist. The needs for the coming 
period, as well as the current liabilities, may have to be studied 
before the answer can be given to the question as to whether or 
not a particular ratio is satisfactory. 

The relation existing between the total current assets and the 
total current liabilities is known as the current ratio. This ratio 
is usually more indicative of the condition of a business than the 
actual excess of current assets over current liabilities in dollars, 



ANALYSIS OF FINANCIAL STATEMENTS 433 

known as working capital. This fact is apparent in a study of 
two organizations having the same amount of working capital. 
For example : 

Company X 

Current Assets $25,000.00 

Current Liabilities 10,000.00 

Working Capital $15,000.00 

Company Y 

Current Assets $150,000.00 

Current Liabilities 135,000.00 

Working Capital $ 15,000.00 

It will be evident that while Company Y has the same amount 
of " working capital " as Company X in dollars, the ratio of 
current assets to current liabilities for Y is only 15 to 13-^, while 
the X company has a ratio of 2\ to i and a much more favor- 
able position. The working capital ratio, therefore, gives a 
much clearer conception of the company's financial position. It 
has often been stated by analysts that a ratio of two to one 
should exist. This is no doubt a safe ratio generally, but in each 
case other factors may have to be studied at the same time 
before any ratio is stamped as satisfactory. 

ANALYSIS OF COMPONENTS OF WORKING CAPITAL 
CURRENT LIABILITIES 

The items comprising this group of accounts represent past 
transactions. These accounts are all fixed; they must be paid 
at par in a relatively short period of time, if the credit of the 
business is to be maintained. Current assets, on the other hand, 
are not so definite and certain. In general, they are funds and 
the items from which funds are to be obtained to liquidate the 
already existing debts, and to carry the immediate financial 
needs of the business such as payroll during the next period. 
It might be well, therefore, to study the several accounts making 
up current assets. 

CASH 

This item should, of course, be free funds available for dis- 
bursement. It should not contain any " non-cash items/ 7 such 
as I.O.U's of officers or employees, postage stamps, or any other 



434 FUNDAMENTALS OF ACCOUNTING 

items not bankable at par. Just how much cash a given concern 
should have could be determined only after a statistical study 
of its past business. Past records should indicate the demands 
for cash under similar circumstances. Naturally, the liquidity 
of the remainder of current assets will have a bearing; funds 
from these sources must be counted upon to augment the exist- 
ing cash balance. 

NOTES RECEIVABLE 

The notes grouped under this caption must be truly current 
assets. They must be good in all respects and relatively short- 
term in order that the funds from these instruments will be 
readily available for a going concern. If notes do not meet these 
two requirements, they should not be included with current as- 
sets. If notes are taken for past due accounts, they may be of 
doubtful value, probably no better than the accounts. Trade 
Acceptances, on the other hand, are usually considered a very 
fine type of negotiable instrument. They arise from a bona fide 
business transaction of a current nature; the passing of mer- 
chandise from the seller to the buyer, and may be drawn only 
for short terms. Long-term notes should be excluded also from 
this caption, because the funds from such instruments will not 
be readily available. 

In order to facilitate the study of notes receivable some such 
classification as the following should be adopted: 

1. Trade Acceptances Receivable. 

2. Customers Notes Receivable. 

3. Notes of Officers and Employees. 

Group 3 might be placed under a separate caption: Other 
Current Assets, or simply Other Assets, depending upon the 
liquidity of the items. 

ACCOUNTS RECEIVABLE 

Listed under this caption should be only good accounts. 
Those accounts known definitely to be worthless should, of 
course, be charged off to the Reserve for Doubtful Accounts. 
Those which are of doubtful value should be transferred to a 
suspense account and kept there, apart from accounts grouped 
as current assets. In addition, a reasonable reserve for doubt- 



ANALYSIS OF FINANCIAL STATEMENTS 435 

ful accounts should be provided against the probability of loss 
from accounts, which are from all current appearances good but 
which may subsequently prove worthless. The sufficiency of 
this reserve can be judged only in light of past experience of a 
particular organization. 

As a further aid in evaluating Accounts Receivable, they 
might be kept in well defined groups as suggested by the follow- 
ing: 

a. Trade Accounts Receivable. 

b. Accounts of Officers and Employees. 

c. Due from Subsidiary Companies. 

d. Accounts in Suspense. 

INVENTORY 

This item, if included in current assets, should also meet the 
requirements set forth for accounts and notes. Namely, all the 
items should be good and salable, and there should be no ques- 
tion of their convertibility into accounts receivable and cash. 
For every item of inventory must first be sold, converted into an 
account receivable, and the period provided in the credit terms 
pass before the proceeds from the sale of the inventory will be 
available for operations. The need for excluding any item 
which will not meet these tests should therefore be apparent. 
In a mercantile organization the inventory usually consists of 
finished goods available for sale in their present condition. Raw 
Materials Inventories in the hands of a manufacturer, on the 
the other hand, may or may not be considered as satisfactory 
current assets, depending on several factors. If raw materials 
are quickly converted into finished goods under normal operat- 
ing conditions, then, everything else being equal, they may be 
considered as good current assets; but, if the manufacturing 
process is lengthy, then there may be a serious question as to 
whether items of this character should be included. The amount 
of inventory compared with the needs for such material should 
be considered. A normal or average inventory may be safely 
included in current assets on the balance sheet of a going con- 
cern, but abnormal investments in inventory should be scruti- 
nized. Too little is likely to be as serious a fault as too much; 
just enough to meet regular normal needs should be carried, 
under ordinary circumstances. The turnover of inventory 



436 FUNDAMENTALS OF ACCOUNTING 

should be studied to ascertain this amount. If a concern uses, 
under normal conditions, $120,000.00 worth of raw materials a 
year and there was a complete turnover each month, then an 
inventory of $20,000.00 would be completely used in sixty days, 
and such an amount might be very satisfactory. 

As a further aid in evaluating this important asset, separate 
inventories should be maintained for each class of stock held. 
For a mercantile organization buying finished goods ready for 
sale, perhaps inventories by principal lines carried might be all 
that is necessary. As a furniture house might list : 

1. Household Furniture. 

2. Specialties. 

3. Radios. 

4. Pianos. 

A manufacturer, on the other hand, will have separate inven- 
tories, such as: 

1. Inventory of Raw Materials. 

2. Inventory of Partly Finished Goods. 

3. Inventory of Finished Parts. 

4. Inventory of Assembled Units. 

5. Inventory of Finished Goods. 

6. Inventory of Manufacturing Supplies. 



ACID TEST RATIO 

Another ratio often used in analyzing financial statements is 
known as the acid test ratio. This ratio compares the total 
quick current assets, made up of cash plus notes receivable and 
accounts receivable to the total current liabilities. In our illus- 
tration, The York Company has $122,000.00 in quick current 
assets, compared with $72,000.00 in current liabilities, or a 
ratio of i .69 to i . It will be noted that the so-called quick cur- 
rent assets are all the current assets except inventory. This 
asset is excluded in making the acid test, because inventories 
must be sold before their proceeds are available; and the uncer- 
tainty of selling, as well as the time involved in the conversion 
of raw materials to finished goods to accounts receivable and 
finally to cash, are the factors which exclude inventories from 
this ratio. An acid test ratio of one to one is usually considered 
a safe ratio. 



ANALYSIS OF FINANCIAL STATEMENTS 437 

OTHER RATIOS 

Some analysts like to compare merchandise inventories to 
accounts receivable. These two items often make up the bulk 
of current assets, and a ratio of merchandise to accounts re- 
ceivable may indicate an important trend. A ratio of fixed as- 
sets to fixed liabilities is also frequently used. Funds obtained 
from fixed liabilities are generally used for the acquisition of 
fixed assets. In our illustrative case, the York Company has 
$120,000.00 in fixed assets, as compared to only $24,000.00 in 
fixed liabilities, giving a ratio of five to one. The use of this 
ratio cannot be very helpful to the analyst. To the writer, its 
use is of little practical significance. The figures in our illus- 
trative case indicate that much of the capital assets were ob- 
tained from the sale of capital stock, or built up over a period 
of years by " plowing back " profits, instead of taking them 
from the business in the form of dividends. 

Another study often used by analysts is the ratio between net 
worth and fixed assets. In our case, the York Company has 
$184,000.00 in net worth and $120,000.00 in fixed assets, a 
ratio of 1.53 to i. This is another ratio of doubtful value be- 
cause the amounts used may result from so many different fac- 
tors. In our case, the ratio indicates that the owners by original 
investment or retention of profits or both have built up this 
favorable ratio. 

There are other ratios used by different analysts, but those 
presented here are illustrative of the most important used in 
studying the Balance Sheet. These ratios alone will mean very 
little; but, compared to another company engaged in a similar 
line of business, they may take on a real significance. For 
the management, they serve their best purpose in compara- 
tive balance sheets. The management compares the items of 
one balance sheet with the items of a prior balance sheet or 
series of prior balance sheets, and in this way may note trends 
and see whether the company is moving forward or backward; 
a going concern cannot stand still. 

COMPARATIVE BALANCE SHEET 

As just pointed out, trends are better studied by the use of 
comparative balance sheets. A going business is always chang- 



438 FUNDAMENTALS OF ACCOUNTING 

ing. A study of comparative statements, profit and loss as well 
as balance sheet, will indicate financial and operating trends, 
and by a careful study of one period with that of another, un- 
favorable conditions may be " spotted " at their inception and 
corrective measures adopted to correct or eliminate the trouble. 
As was stated before, comparisons must be made from both 
statements but just now we shall confine ourselves to a study of 
comparative balance sheets, after which we shall study com- 
parative profit and loss statements. 

ILLUSTRATION 

In order to simplify our presentation, in the illustrative bal- 
ance sheet, assets are shown net of reserves. This will in no 
way affect the principles involved, and that, of course, is what 
we are primarily interested in. 

SOME OBSERVATIONS FROM ILLUSTRATION 

In the illustration opposite the current balance sheet of the 
York Company is compared with the balance sheet of one year 
ago. The increase or decrease in amounts of each item is listed, 
followed by the ratio that the current year's figures bear to the 
last previous year. 

As the current year's figures have already been discussed, 
only current trends observed from a comparison of the current 
year and the past year will be mentioned. 

WORKING CAPITAL 

The current working capital ratio is 2.08 to i, or 2 08 %, while 
for the last year it was only 1.82 to i, or 182^, an increase of 
16%, which is a very fine improvement. The acid test ratio 
for the current year as previously determined is 1.69, while for 
last year it was 1.48, an increase in favor of the current year 
of 21%. This increase is accounted for first by an increase 
in current assets of $10,000.00, and secondly by a decrease 
in current liabilities of $5000.00. Then, too, the individual 
items comprising the current assets might be compared. Cash 
shows a healthy increase 107% of the last year's figure. While 
the current amount of Notes Receivable has declined some 14% 
as compared with the last year's figure, this may indicate a good 



ANALYSIS OF FINANCIAL STATEMENTS 439 



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condition; perhaps some of the notes have matured and have 
been paid in cash. There is also a good increase in Accounts 
Receivable. This may simply mean an increase in the volume 
of business. The Notes Payable to Banks have been reduced, 
as have the Trade Notes Payable; both of these trends are very 
fine, and a condition the banker likes to see as he compares one 
period with another. All in all, there seems to be a good, healthy 
condition existing in the current situation of the York Company. 
All the trends, as far as working capital is concerned, are point- 
ing in the right direction. There has been a slight increase in 
the deferred assets; this is caused by an increase in Prepaid 
Advertising. Ordinarily this is a healthy sign. It indicates that 
the company may have spent more to advertise; and, if its trend 
is toward an increase in volume of business (as might be indi- 
cated in the increase in Accounts Receivable), it looks like a 
good move to have increased the advertising. 

As we look at the fixed assets, we note that the total for this 
year is less than that for last year. Looking a little closer, we 
may note that there has been a decline in the net value of Build- 
ings and Machinery and Equipment. We must remember, how- 
ever, that these accounts are exhibited net of depreciation; 
therefore, this apparent shrinkage in amount may be wholly due 
to depreciation. We may note further that the Delivery Equip- 
ment has been increased despite depreciation. This no doubt 
indicates the purchase of a new truck. This observation is ob- 
vious if we look at the fixed liabilities contra] there we see 
$4000.00 in Notes on Delivery Equipment. Therefore, while 
the total net value of Delivery Equipment is up $2000.00 the 
offsetting notes payable of $4000.00 indicates clearly that there 
has been recorded appropriate depreciation. This is always 
a good sign and one frequently observed by the banker. He 
likes to see that depreciation is adequately provided. 

We might go on with other observations, but those given will 
suffice to illustrate what may be done with comparative balance 
sheets. 

ANALYSIS OF THE PROFIT AND LOSS STATEMENT 

A profit and loss statement for The York Company is pre- 
sented on page 442 and reviews its activities for the current 
year. 



ANALYSIS OF FINANCIAL STATEMENTS 441 

The statement overleaf has listed on the right a percentage 
column, which will facilitate comparison of the several items on 
the statement. " Net Sales " is the basis of comparison and 
therefore marked 100%. The returns and allowances were 3.3, 
indicating that The York Company found it necessary to sell 
$103.30 worth of merchandise to yield $100.00 in completed 
sales. The volume of returns is not unreasonably high, and 
might be considered very low for certain lines of business. One 
fundamental point mentioned before must be kept in mind also 
at this time a study of any fact, factor, or result is practically 
worthless unless some standard or at least other similar case 
or set of figures is available for comparison. For, while $% 
returns may be an excellently low figure for one business, an- 
other business might consider 10% very satisfactory. 

Similarly we might observe that for the current year The 
York Company's net profit amounted to 7.34% of the net sales. 
This figure, too, can have significance only if compared with 
the results of another year's operation of The York Company. 
Such a comparative statement is now presented, after which a 
series of more or less commonly used observations will be 
discussed. 



SOME OBSERVATIONS FROM COMPARATIVE INCOME 
STATEMENTS 

TOTAL NET SALES 

This figure should be given consideration by the manage- 
ment. In our case at hand the current year's net sales are 
J5 5000.00 greater than the last. The figure should be compared 
with that of the second year previous, too, in order to see if 
there is a steady improvement. Often Profit and Loss State- 
ments for five years back will be compared in order to get a 
better view of the trend over a longer period. 

COST OF GOODS SOLD 

In this case, we note a rather unusual situation: the same 
dollar amounts for cost of goods sold; the percentage to net 
sales, however, is 58% in the current year against 60% the pre- 
vious. The several items composing the cost of goods sold 



442 FUNDAMENTALS OF ACCOUNTING 

might now be compared, and it will be noted that the separate 
items are very close in dollar value as well as percentages. 



THE YORK COMPANY 

Statement of Income Profit and Loss 

for the Current Year 

__ 

Gross Income from Sales $155,000.00 3.3 

Less Returns & Allowances _5? ooo ^. I0 3-3 

Net Income from Sales 150,000.00 100.0 

Less the Cost of Goods Sold: 

Old Inventory $ 26,000.00 J 7-33 

Add Purchases .... $91,000.00 60. 6 1 

Less Returns . 2,000.00 1.33 

89,000.00 59.28 

Total Merch. Avail, for Sale . 115,000.00 76.61 

Less New Inventory 28,000.00 18.66 

Cost of Goods Sold 87,000.00 58.00 

Gross Profit 63,000.00 42.00 

Deduct Selling Expense: 

Salesmen's Salaries 12,000.00 8.00 

Advertising 10,000.00 6.67 

Delivery Expense 3,200.00 2.13 

Depreciation on Deliv. Equip. 1,400.00 .93 

26,600.00 17.73 

36,400.00 24.27 
Deduct General and Administrative Expense: 

Office Salaries 9,000.00 6.00 

Taxes 1,400.00 .93 

Insurance 6,000.00 4.00 

Telephone & Telegraph 800.00 .53 

Heat & Light 1,300.00 .87 

Dep. of Buildings 5,400.00 3.60 

Dep. of Mach. & Equip 1,500.00 i.oo 

25,400.00 16.93 

Net Profit $i 1,000.00 7.34 



GROSS PROFIT 

This figure for the current year is $63,000.00 and for the 
year previous $58,000.00 or a gain of $5000.00. This gain is 
not so significant, however, when taken in respect to the total 



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444 FUNDAMENTALS OF ACCOUNTING 

net sales for each year. The gross profit compared to net sales 
this year is 42%, whereas last year it was 40%, a slight dif- 
ference in favor of the current year. 



SELLING EXPENSES 

The selling expenses advanced in the current year $2800.00 
over those of the former year. This increase, however, seems 
to be justified due to the fact that a greater volume of sales was 
produced and, too, a greater percentage of net profit. It will 
be noted that the advertising figure is $1000.00 higher for the 
current year; this may be one of the factors causing the in- 
crease in sales. The delivery expense was actually lower, de- 
spite an increase in volume of sales in the current year, than in 
the previous year. This may be due to new equipment or more 
efficient handling of deliveries. 



GENERAL AND ADMINISTRATIVE EXPENSE 

A study of these items will reveal very little variation ; as a 
matter of fact, the total for each year is the same. This brings 
out a very interesting point in management, a study of the so- 
called fixed and variable costs. 



FIXED AND VARIABLE EXPENSES 

It will be noted that the Depreciation of Buildings, also Ma- 
chinery and Equipment is identical. This often happens when 
there has been no change in the fixed assets. The same rate of 
depreciation will be applied and, of course, the same " fixed " 
amounts will result. The office salaries, too, are the same for 
both years under review, but note that the salesmen's salaries 
have been increased in the current year $1000.00 over the past 
year. Salesmen's salaries, commissions, delivery costs, adver- 
tising, and items of this character are known as variables, be- 
cause they will vary usually with the volume of business 
handled. Interest cost, management wages, taxes, and insur- 
ance, as well as depreciation referred to before, are usually fixed 
and cannot be reduced very much by management. For this 
reason every concern has certain " overhead costs of fixed ex- 



ANALYSIS OF FINANCIAL STATEMENTS 445 

penses " which it must meet before it can hope to make any 
profit. If the minimum amount of fixed expense is known, the 
company can usually figure just what its volume of business 
must be to " clear expenses." That is known as the " break- 
even " point. Any increase in sales volume beyond that point 
will ordinarily result in a net profit. Care must be taken, how- 
ever, to see that the variables do not increase in a greater pro- 
portion than the increase in sales volume. Executives, control- 
lers, and accountants have been giving a great deal of thought to 
this problem of late, and there is no doubt but that careful study 
of a company's expenses will yield much important information 
regarding a so-called " break-even " point. One of the problems 
involved, however, is to classify the so-called variable and fixed 
expenses. It is a rather hard task to make a rigid classification, 
for even such a fixed expense as rent must be increased 
after sales volume is increased beyond a certain point. Also 
some expenses increase in a more exact proportion to sales than 
do other variables. 

OTHER RATIOS 
NET PROFIT TO NET WORTH 

This ratio is often studied and found helpful. It indicates 
whether or not the investment of the proprietors is being profit- 
ably employed. The York Company had a net worth in the 
current year of $184,000.00 and earned $11,000.00, yielding a 
return of slightly better than six per cent. This figure is cer- 
tainly not a high figure, but the current general business condi- 
tions must be kept in mind, and a return of six per cent may be 
a fairly good return, everything else considered. 



QUESTIONS ON THE CHAPTER 

1. What do you understand by analysis? 

2. (a) Name two groups other than the management interested 
in the study of financial statements. 

(b) What are some of the particular problems of each group? 

3. It has been said that the proper valuation of assets has been 
very intimately connected with the interpretation of the balance sheet. 
Explain. 

4. Which statement is the more valuable to the banker in deciding 
on the advisability of granting a loan application? Why? Explain. 



446 FUNDAMENTALS OF ACCOUNTING 

5. Explain the advantages claimed for proper classification of ac- 
counts. 

6. (a) Outline briefly a model classification. 
(b) What are its superior points? 

7. Explain the procedure or technique of setting up a balance 
sheet on working paper for proper analysis. 

8. Explain: 

(a) Working capital. 

(b) Current ratio, 
(r ) Acid test ratio. 

9. Give a good definition of current assets and current liabilities. 

10. How should Accounts Receivable be displayed to aid in their 
evaluation? 

11. How should Notes Receivable be displayed to aid in evaluation 
of this asset? 

1 2 . How should Inventories be classified and grouped to aid in their 
evaluation? 

13. What advantages are there to the use of comparative balance 
sheets? 

14. Discuss the study of a profit and loss statement. 

(a) Use of percentages as an aid in interpretation. 

(b) Comparative statements. 

15. Discuss some of the important ratios taken from a study of 
comparative profit and loss statements. Give the significance of each. 

1 6. Discuss fixed and variable expenses. 

17. Explain break-even point. 



PROBLEM MATERIAL 

PROBLEM i 

Condensed Balance Sheets are given below for two competing or- 
ganizations: 

THE HARRIS COMPANY 

Current Assets $ 40,000.00 Current Liabilities $ 20,000.00 

Fixed Assets 160,000.00 Fixed Liabilities 60,000.00 

Capital Stock 100,000.00 

_ Surplus 20,000.00 

$200,000.00 $200,000.00 

THE FORBES COMPANY 

Current Assets $150,000.00 Current Liabilities $100,000.00 

Fixed Assets 200,000.00 Fixed Liabilities : 130,000.00 

Capital Stock 100,000.00 

Surplus 20,000.00 

$350,000.00 $350,000.00 



This Year 


Last Year 


Year 
Before Last 


$ 6,000.00 
16,000.00 
4,000.00 
28,000.00 


$ 4,000.00 
14,000.00 
5,000.00 
25,000.00 


$ 5,000.00 

12,000.00 

6,000.00 
20,000.00 


$54,000.00 
$25,000.00 


$48,000.00 
$24,000.00 


$43,000.00 
$23,000.00 









ANALYSIS OF FINANCIAL STATEMENTS 447 

Required: 

1 i ) The amount of working capital of each. 

( 2 ) The working capital ratio of each. 

(3) Compare the two companies as to working capital, value of 
shares, etc. 

PROBLEM 2 

The following are the current assets and liabilities of the Sandow 
Company for the past three years: 



Current A ssets 

Cash 

Accounts Receivable (Net of Res.) 

Notes Receivable 

Inventories 

Current Liabilities 



Required: 

(1) Compute the percentage each current asset bears to the total. 

(2) Compute the current ratio for each year. 

(3) What are some of the factors which might have caused this 
condition ? Discuss. 

PROBLEM 3 

Given the following account titles, rearrange them in the best order 
to facilitate the preparation of financial statements: 

Taxes, Purchases, Light, Heat and Power, Land and Buildings, Pur- 
chase Discounts, Cash, General Expense, Inventory Coal, Furniture 
and Fixtures, Notes Receivable, Sales, Petty Cash Fund, Deprecia- 
tion of Delivery Equipment, Taxes Payable, Salaries of Salesmen, 
Return Sales, Accounts Receivable, Good-will, Royalty Expense, De- 
preciation of Buildings, Reserve for Depreciation of Delivery Equip- 
ment, Bonds Payable, Capital Stock, Freight and Cartage Inward, 
Mortgage Payable, Long-term Notes Receivable, Long-term Notes 
Payable, Reserve for Doubtful Accounts, Patent Rights, Temporary 
Investments, Inventory Merchandise New, Prepaid Insurance, Re- 
serve for Depreciation of Buildings, Machinery and Equipment, Pre- 
paid Advertising, Salaries Payable, Accounts Payable, Subscriptions 
Income, Subscriptions Received in Advance, Depreciation of Delivery 
Equipment, Return Purchases, Gas and Oil, Surplus, Travel Expense. 

PROBLEM 4 

The following trial balance is taken from the books of the Kirkland 
Company, Inc., at December 31, current year, followed by supple- 
mentary data required to adjust and close the books. 



FUNDAMENTALS OF ACCOUNTING 



THE KIRKLAND COMPANY, INC., CURRENT YEAR 

Trial Balance 



Acct. Account Title 
No. 

1 Cash 

2 Petty Cash Fund 

3 Notes Receivable 

4 Accounts Receivable 

5 Reserve for Doubtful Accounts . . . 

6 Delivery Equipment 

7 Land & Buildings 

8 Machinery & Equipment 

9 Inventory January 2 

10 Maintenance of Del. Equipment . 

1 1 Purchases 

12 Purchase Returns & Allowances . . 

13 Sales 

14 Sales Returns 

1 5 Capital Stock 

1 6 Surplus 

17 Bonds Payable 6% 

18 Notes Payable 

19 Reserve Dep. Mach. & Equip 

20 Reserve Dep. Buildings 

21 Reserve Dep. Delivery Equipment 

22 General Office Expense 

23 Interest Income 

24 Interest Expense 

25 Accounts Payable 

26 Sales Expenses 



$ 6,420.00 

200.00 

3,400.00 

46,000.00 

13,600.00 
80,000.00 
66,000.00 
16,540.00 
148.00 
68,750.00 



2,450.00 



$ 1,896.00 



12,820.00 

1,815.00 

12,390.00 



1,120.00 
114,450.00 

100,000.00 

13,382.00 

50,000.00 
8,500.00 
2,800.00 
4,000.00 
4,600.00 

624.00 
29,161.00 



$330,533-00 $330.533.00 



Supplementary Data: 

(1) The merchandise inventory at December 31 is $18,400.00. 
Depreciation Annual Rates: 

( 2 ) Buildings valued separately $70,000.00 2 % 

(3) Machinery & Equipment 10% 

(4) Delivery Equipment 25% 

(5) Increase the Reserve for Doubtful Accounts so that it shall 
equal 5% of Accounts Receivable. 

(6) Accrue one-half of the Annual Bond Interest which will be pay- 
able January 2 . 

(7) A dividend of 3% on all shares outstanding was declared De- 
cember 20 to holders of record December 3 1 and payable Janu- 
ary 15. 



ANALYSIS OF FINANCIAL STATEMENTS 449 

Required: 

1 i ) Adjust and close the books for the current year. 

( 2 ) Prepare a profit and loss statement for the current year. 

( 3 ) Prepare a balance sheet for the current year. 



PROBLEM 5 

The trial balance listed below is taken from the books of the Kirk- 
land Company, Inc., at December 31 last year, together with supple- 
mentary data required to close and adjust the books at that time. 



Acct. 
No. 



THE KIRKLAND COMPANY, INC. 
Account Title 



i 

2 

3 
4 

5 
6 

7 
8 

9 
10 
ii 

12 
13 
14 
15 

16 

17 
18 

19 

20 
21 

22 

23 
2 4 

25 



Cash 

Petty Cash Fund 

Notes Receivable 

Accounts Receivable 

Reserve for Doubtful Accounts . 

Delivery Equipment 

Land & Buildings 

Machinery & Equipment 

Inventory January 2 

Maintenance of Del. Equipment 

Purchases 

Purchase Returns & Allowances 

Sales 

Sales Returns 

Capital Stock 

Surplus 

Notes Payable 

Reserve Dep. of Mach. Equip. . 

Reserve Dep. of Buildings 

Reserve Dep. of Del. Equipment 

Office Expense 

Interest Income 

Interest Expense 

Accounts Payable 

Sales Expenses 



(LAST YEAR) 
Trial Balance 

5,800.00 

200.00 

3,600.00 

42,000.00 



1,500.00 



12,000.00 
80,000.00 
18,000.00 
14,500.00 
360.00 
62,140.00 



1,660.00 



16,482.00 

110.00 

14,530.00 



1,140.00 
107,660.00 

100,000.00 
7,282.00 
15,500.00 
1,000.00 
2,600.00 
1,600.00 

138.00 
32,962.00 



$271,382 .00 $271,382.00 



Supplementary Data: 

(1) The New Inventory at December 31 is $16,540.00. 

(2 ) Depreciation Machinery & Equipment 10% . 

(3) Depreciation Buildings valued separately $70,000 2%. 

(4) Depreciation Delivery Equipment 25%. 

(5) Increase the Reserve for Doubtful Accounts $396.00. 



450 FUNDAMENTALS OF ACCOUNTING 

(6) A dividend of 3% on all shares outstanding was declared De- 
cember 20 to holders of record December 31 and payable Janu- 
ary 15. 

Required: 

1 i ) Adjust and close the books for the last year. 

( 2 ) Prepare a profit and loss statement for the last year. 

(3) Prepare a balance sheet for the last year. 

PROBLEM 6 

Using the Kirkland Company balance sheet current year: 

(1) Compute the ratio each asset and each liability bears to the 
total assets and liabilities. 

(2) Compute the current ratio. 

(3) Compute the acid test ratio. 

PROBLEM 7 

Using the Kirkland Company balance sheet for the last year: 

(1) Compute the ratio each asset and each liability bears to the 
total assets and liabilities. 

( 2 ) Compute the current ratio. 

(3 ) Compute the acid test ratio. 

PROBLEM 8 

Using the balance sheets of the Kirkland Company for the present 
and the past years, prepare a comparative balance sheet, showing in- 
crease or decrease in each item, in both amount and percentage. 

PROBLEM 9 

Using the profit and loss statements of the Kirkland Company for 
the present and the past years, prepare a comparative profit and loss 
statement showing increase or decrease in each item in both amount 
and percentage. 



COLLEGE BOOK SHOP 
PRACTICE SET 

Unit No. i 

September 2, 19 

Mr. J. M. Andrews, proprietor of the College Book Shop, asks you 
if you will take a part-time position in his store to help behind the 
counter and to operate a very simple set of books for him. He knows 
very little about bookkeeping and is satisfied with your suggestion to 
operate a General Journal and a standard Double Entry Ledger. He 
outlines to you what he has done to date as follows: 

He has opened a bank account with the Peoples' Bank, depositing 
$2500.00, obtained as follows: $500.00 from his own funds and a 
check $2000.00, from his father, Thomas Andrews, who loans him 
this on a non-interest-bearing demand note. 

He has drawn check No. i, for $2.00, to order of County Clerk to 
register trade name "College Book Shop." Check No. 2, $75.00 is 
drawn to Middlesex Realty Company, rent for i month, September i 
to October i, on vacant store at 240 Henry Street. 

You accept the position, and record the transactions above under 
date of September 2, after which you journalize and post the follow- 
ing transactions: 
September 3, 19 

He has installed show cases and other store equipment from N. Y. 
Office Supply Co., and is billed $840.00, net thirty days. 

Mr. Andrews purchases a cash register from the International Busi- 
ness Machines Co., for $300.00, payable $50.00 down and $50.00 per 
month for five months. A check for $50.00 is drawn and a finance 
note is signed for the balance to be paid $50.00 each month starting 
October fourth. 

He pays New Brunswick Decorating Company, $76.00 for painting 
and decorating store, check No. 4. 

He pays $5.00, check No. 5, to Art Sign Co., for lettering on the 
windows. 
September 4, 19 

A shipment of textbooks arrives from the Blue Book Company to- 
gether with invoice $140.00, terms net 30 days. 

A shipment of texts arrives from Merit Book Company Net Cost 
$164.80, terms net 30 days. 

N. Y. Stationery and Supply Co., shipment of stationery and sup- 
plies arrives $382.80, terms net 30 days. 

He gives check No. 6, to Daily News, $40.00 for advertisement. 
September 5, 19 

A shipment of advertising novelties which are to be given to cus- 



452 FUNDAMENTALS OF ACCOUNTING 

tomers on opening day arrives from Metropolitan Advertising Co., 
cost $13.75 C.O.D., for which he draws check No. 7. 

He pays cash, check No. 8, $12.00 for cleaning store preparatory 
to opening. 
September 7, 19 

The store opens for business and the cash sales for the day were 
$124.50. 

A shipment of books arrives from N. Y. Book Co. $642.00, terms 
2/10 n/30. 

Postage stamps are purchased, for which you cash check No. 9, 
$6.00. 

(From this point forward you draw all checks for Mr. Andrews, 
and keep record of check numbers.) 
September 9, 19 

Mr. Andrews asks you to draw a check for $75.00, and have it 
cashed for payroll. 

Cash Sales for the day were $89.00. 

A telegram arrives $1.50, collect, and you draw a check. 

Mr. Andrews asks you if it is not possible to operate a Petty Cash 
Fund, and after you explain its operation, he authorizes you to draw 
a check for $25.00, to establish the fund. 
September 10, 19 

Cash Sales for the day were $185.00. 

A shipment of Sporting Goods arrives from Spaulding and Co., 
billed $824.00, terms 2/10 n/30. 

Mr. Andrews needs shelves and storage cabinets for the rear of the 
store, and receives a bid from the Unit Steel Co., of $800.00 for the 
equipment required. He feels he cannot afford steel equipment and 
has a carpenter construct them for him, paying cash for the following 
bills: to New Lumber Co. for lumber $180.00, to Strong Hardware 
Co. for hardware and paint $40.00, to carpenter and helper salary as 
per agreement $100.00. 
September //, 19 

Mr. Andrews asks you to pay the following accounts: Blue Book 
Company invoice of September 4th, Merit Book Company, invoice 
September 4th. 

A student returns a textbook which is defective and you give him 
another which cost $2.80. You send the defective text back to the 
Blue Book Company, and request a credit memo. 

Cash Sales for the day were $201.10. 
September 12, 19 

Mr. Andrews has arranged a loan with his bank in amount of 
$1000.00. The bank takes his 6o-day note and credits his account 
with $990.00. 

An invoice from The City Sales Co., in amount of $120.00, terms 
3/10 n/30, arrives with shipment. 

Cash Sales for the day amount to $214.00. 



PRACTICE SET 453 

September 13, ig 

Advertising for week is paid by check to Dally News $40.00. 

Received shipment from Metropolitan Envelope Supply Co., in- 
voice $36.00, terms 2/10 11/30. 

A credit memo arrives from the Blue Book Company $2.80 for text 
returned September 1 1 . 

Cash Sales for the day amount to $210.00. 
September 14, ig 

A salary check is drawn for $75.00. 

Cash Sales for the day amount to $365.00. 
September 16, ig 

Mr. Andrews approves for payment the following invoices: 

September 3rd N. Y. Office Supply Co. 

September 4th N. Y. Stationery and Supply Co. 

Cash Sales for the day were $115.00. 
September 17, ig 

A shipment of books arrives from the Blue Book Company, invoice 
$i 1 6. oo, terms net 30 days. 

A shipment of books also arrives from N. Y. Book Co., invoice 
$146.00, terms 2/10 n/30. 

Cash Sales for the day were $189.00. 
September 18, ig 

A shipment of sundries arrives from College Supply Co., $78.00, 
terms 2/1011/30. 

A shipment from N. Y. Pen Supply Co., arrives $320.00, terms 
3/10 n/3o. 

Cash Sales for the day amount to $215.00. 
September ig> ig 

N. Y. Sporting Goods Co., shipment arrives $820.00, terms 2/10 
n/3O. Several pens received yesterday were damaged, and had to be 
returned for credit, cost price $12.60. (Make no entry until word is 
received from N. Y. Pen Supply Co.) 

Merit Book Company shipment totaling $120.00 is received, terms 
2/10 n/30. 

Cash Sales for the day total $186.00. 
September 20, ig 

A student returns a tennis racket split in play, and, after examina- 
tion, you give him another, cost to you is $6.00. Postage for an ad- 
vertising circular is required, and check drawn for $21.00 is cashed 
at the bank. Mimeographing Service Co., invoice for $34.00 is re- 
ceived for advertising circular. Terms Net 30 days. 

Cash Sales for the day amount to $182.00. 
September 21, ig 

You send broken tennis racket back to N. Y. Sporting Goods Co. 
together with a letter requesting proper credit. (No entry until word 
is received from company.) 

Cash Sales for the day amount to $119.00. 



454 FUNDAMENTALS OF ACCOUNTING 

September 23, 19 

Mr. Andrews asks you to pay the following bills: Metropolitan 
Envelope Supply Co., September i3th, less discount, and City Sales 
Invoice, September i2th, less discount. 

A credit memo is received from N. Y. Pen Supply Co., total $13.00; 
$12.60 for pens, 40^' postage on returned package. 

Weekly Advertisement $40.00 is paid to Daily News. 

Salary check $75.00 is drawn for week, ending September 2ist. 

Cash Sales for the day were $296.00. 
September 24, 19 

Mr. Andrews asks you to draw a $15.00 check for advertisement 
in college football program. 

Mr. Andrews instructs you to pay the Blue Book Company, invoice 
of September iyth, less credit memo; and invoice of September lyth, 
of N. Y. Book Co., less the discount, and to give a 6o-day note to 
N. Y. Book Company for invoice of September yth. 

A new typewriter is purchased from the International Business 
Machines Co., $125.00, terms 2% for cash in 30 days, or Net 60 days. 

An office desk is purchased from local used-furniture company 
$18.00 cash draw check to Cash. 

Cash Sales for the day were $2 14.00. 
September 25, 19 

A credit memo arrives from the N. Y. Sporting Goods Co. for $6.00, 
full allowance for racket returned. 

A shipment of 250 gallons of fuel oil is received from the Plainfield 
Oil Co., 7^ a gallon, net 30 days. 

One textbook is returned by student and another given in place, 
cost $2.80, book is returned to the Blue Book Company for credit. 

Cash Sales for the day amount to $2 10.00. 
September 26, 19 

Mr. Andrews asks you to pay N. Y. Pen Co., invoice of September 
1 8, less credit memo and discount. 

Paid $12.00 by check for services to oil burner. 

Paid $16.00 by check for window cleaning to date. 

Cash Sales for the day were $185.00. 
September 27, 19 

A check in amount of $20.00 received from Thomas Brown, a stu- 
dent, is returned from our bank marked " insufficient funds " together 
with protest charges of $2 .40. Mr. Andrews phones Brown who prom- 
ises to pay next day. 

A shipment arrives from the N. Y. Sporting Goods Co., in amount 
of $126.00, Terms 2/10 n/3O. 

Cash Sales for the day were $216.00. 
September 28, 19 

Drew salary check for week $75.00. 

Paid Daily News $40.00 for advertisement. 

Cash Sales for day $i 10.00. 

Received $22.40 in cash from Mr. Brown for protested check. 



PRACTICE SET 455 

September 30, IQ 

Mr. Andrews instructs you to pay the Merit Book Company, invoice 
September 19, less discount. 

Your Petty Cash Fund is $2.60, and vouchers total $22.40, which 
you classify as follows: 

Postage $ 6.18 

Express 8.12 

Tel. & Tel 2.80 

General Expense 5.30 

$22.40 

Draw a reimbursing check debiting the above accounts, as indi- 
cated. 

Cash Sales for the day were $125.60. 

Required: 

1 i ) Journalize the foregoing transactions in a standard two column 
general journal. 

(2) Post the journal to a standard ledger. Allow one page for the 
cash account, the sales account, and for purchases; all other 
accounts four to a page. 

(3) Take a trial balance of the general ledger. 



PRACTICE SET 

Unit No. 2 

To be used after Chapter on Special Journals has been 
completed. 

Mr. Andrews has decided to expand his business and has arranged 
with several wholesale companies to act as their agent in New Bruns- 
wick and vicinity. He wishes his Purchases and Sales classified as 
" Books and Stationery " and " Sporting Goods and Sundries." 

The Purchases account in total, September 30, was $4024.00 and 
is analyzed " Books and Stationery " $1826.50, " Sporting Goods and 
Sundries' 7 $2197.50. Write a Journal Entry, closing the old Pur- 
chases account and open two new Purchases accounts, as indicated 
above. 

The Sales Account is similarly analyzed, " Books and Stationery," 
$2240.00, " Sporting Goods and Sundries " $1511.20 and is also to 
be closed by a Journal Entry opening two Sales accounts for the two 
departments. 

The Bookkeeper installs four special journals as follows: 

(i) A Cash Receipts Book, designed to record all cash received, 
with the following layout: Date, Account Credit, Explanation, Folio, 
Total Amount, Discount on Sales, and Net Cash Received. 



456 FUNDAMENTALS OF ACCOUNTING 

( 2 ) A Cash Disbursements Book, designed to record all cash paid 
'out with the following layout: Date, Account Debit, Explanation, 
Folio, Total Amount, Discount on Purchases, and Net Cash Paid. 

(3) A Sales Journal to record all Sales and laid out as follows: 
Date, Account Debit, Explanation, Folio, Books and Stationery, 
Sporting Goods and Sundries. 

(4) A Purchase Journal to record all purchases and laid out as fol- 
lows: Date, Account Credit, Explanation, Folio, Books and Station- 
ery, Sporting Goods and Sundries. 

The General Journal will be continued, but only for those transac- 
tions which cannot be entered in the special journals. 

Using the special journals above which are purchased from 
Petty Cash, record the following transactions, October i to 15, 
inclusive. 

October i, ig 

Purchased sporting goods from Spaulding and Co., terms 2/10 
n/3O, total $213.00. 

The following sales were made on account. Middlesex Junior Col- 
lege Books and Stationery $i 16.00, Net 30 days. 

Johnson and Johnson Stationery $64.00, terms 2/10 n/3O. 

Thomas Haggerty Stationery $180.00, terms 2/10 11/30. 

The Cash Sales for the day were Books and Stationery, $45.00, 
and Sporting Goods and Sundries, $10.00, in future all Sales of 
Books and Stationery will be designated ( i ) , and Sporting Goods and 
Sundries designated ( 2 ) . 
October 2, 19 

The following accounts are paid net Spaulding, invoice, Septem- 
ber 10 $824.00; Rent one month $75.00. First payment to Inter- 
national Business Machines Co., on Note due today, $50.00. 

The following sales were made on account: 

N. B. High School Sporting Goods, $210.00, Net 30 days. 

South River Board of Education Books and Stationery, $i 10.00, 
net 30 Days. 

South River Athletic Association Sporting Goods $240.00, net 
.30 days. 

The Cash Sales for the day were (i) $16.00; (2) $62.00. 

Invoice Received from N. Y. Office Supply Co., Stationery $428.00 
and Sundry Items $36.00, terms 2/10 n/3o. 
October 3, 19 

Sold to Middlesex Junior College Books $85.00, terms 2/10 n/30. 

Cash Sales for the day were ( i ) $64.00 ; ( 2 ) $51 .00. 

Invoice received from N. Y. Sporting Goods Co., $160.00, terms 
2/10 n/30. 

Gave our check to College Supply Co., for invoice September 18, 
net $78.00. 



PRACTICE SET 457 

October 4, ig 

Sold on account to: Johnson and Johnson, Stationery $48.00, terms 
2/10 n/30. 

Rutgers Athletic Association, sporting goods $60.00, net 30 days. 

Cash Sales for the day were (i) $60.00, (2) $92.00. 

Purchased from City Sales sundries $38.00, 2/10 n/3o. 

Sent our check to N. Y. Sporting Goods Co., $440.00 and our 60- 
day non-interest-bearing note for $500.00 in full payment of our ac- 
count, invoices September 19 and 27. 
October 5, ig 

Received check $176.40 payment in full invoice, October i, Thomas 
Haggerty. 

Sold to N. B. High School, sporting goods $16.00, net 30 days. 

Paid salaries for week by check $75.00. 
October 7, ig 

Paid Mimeographing Service Co. account in full $34.00. 

Cash Sales for 5th and 7th were (i) $114.00, (2) $93.00. 

Sold Books to South River Board of Education, $23.00, net 30 days. 

Received check from Johnson and Johnson, full settlement of in- 
voice, October i. 
October 8, IQ 

Sold Stationery to National Bank of N. J., $60.00, Terms 2/10 
n/30. 

Received check from South River Board of Education, invoice of 
October 2 in full. 

Cash Sales for day were (i) $45.00, (2) $18.00. 

Purchased Envelopes from Metropolitan Envelope Supply Co., 
$142.00, Terms 2/10 n/3O. 
October g, ig 

Sold stationery to Beck Shoe Store, $16.00, terms 2/10 n/3o. 

Sold to Middlesex Junior College texts, $72.00, terms net 30 days. 

Accepted offer from Home News, we to pay them $120.00 for four 
weeks, advertising in advance, and issued check accordingly. 
October 10, ig 

Purchased a light delivery truck from Rutgers Chevrolet Co., full 
price $865.00. They accept our check for $300.00 and our ten-month 
note for the balance, payable $56.50 per month. 

Drew a check $86.00 to Frank Merritt, Insurance broker, for fire, 
theft, and public liability insurance on new truck. 

Gave a check to Spaulding and Co., $208.74, full payment of their 
invoice October i. 

Received a check from New Brunswick High School, invoice of Oc- 
tober 2, in full. 

Purchased athletic equipment from Spaulding and Co., $475.00, 
terms 2/10 n/3o. 

Purchased Sundry items from College Supply Co., $190.00 with 
special terms 3/10 n/30. 

Cash Sales for 9th and zoth were (i) $110.00, (2) $48.00. 



458 FUNDAMENTALS OF ACCOUNTING 

October 11, ig 

Sold stationery to Thomas Haggerty $2 i.oo, Terms 2/10 11/30. 

Sent our check $454.72 to N. Y. Office Supply Co. in full settlement 
invoice, October 2. 

Received a check $47.04 from Johnson and Johnson, invoice, Octo- 
ber 4, in full. 

Received invoice from the Blue Book Company for texts $260.00, 
net 30 days. 

Received invoice from the Merit Book Company for texts $281.00, 
net 30 days. 
October 12, ig 

We returned novelties received in damaged condition, and received 
a credit memo from College Supply Co., cost $12.40. 

Drew check $75.00 weekly salaries. 

Sold athletic equipment to South River Athletic Association $64,00, 
net 30 days. 

Cash Sales for October n and 12, were (i) $140.00, (2) $31.00. 
October 13, ig 

Received a check from Beck Shoe Store, $15.68, full payment of 
invoice of October 9. 

Invoices received from N. Y. Book Co., texts $296.00, net 30 
days, and from N. Y. Sporting Goods Co. Golf Equipment $125.00, 
terms 2/10 n/30. 
October 14, ig 

Sold athletic equipment to Rutgers Athletic Association $72.00 
net 30 days. 

Cash Sales for i3th and i4th were (i) $70.00, (2) $49.00. 

Gave Plainfield Oil Co. our check $17.50, and received a delivery 
of fuel oil 200 gals., at 6 cents, terms net 30 days. 

Received a check $58.80 from National Bank of N. J., full settle- 
ment of invoice October 8. 
October 15, ig 

Sold stationery to Beck Shoe Store $64.00, terms 2/10 n/30. 

Gave our check to City Sales $37.24, full payment, invoice Octo- 
ber 4, and our check to George Street Service Station $22.00, for gas 
and oil account to date. 

Cash Sales for today were (i) $22.00 and (2) $18.00. 

Required: 

(1) Total all books of original entry. (These totals will be 
checked in class.) 

(2) Post all books of original entry to the general ledger. Use 
the same accounts as before, opening new accounts as required. 

(3) Take a trial balance of the general ledger as of October 15. 



PRACTICE SET 459 



PRACTICE SET 

Unit No. 3 
To be used after Controlling Accounts have been presented. 

October 16, 19 

Mr. Andrews has agreed that it would be a good idea to establish 
an Accounts Receivable Ledger and an Accounts Payable Ledger, and 
establish appropriate controlling accounts in the General Ledger to 
take the place of the individual accounts transferred. 

With this change in mind, you design five special journals as 
follows : 

(1) A Purchase Book with column headings from left to right as 
follows: Date, Account Credit, Explanation, Folio, Accounts Payable 
Cr., Books and Stationery Dr., Sporting Goods and Sundries Dr. 

(2) A Sales Book with column headings from left to right as fol- 
lows: Date, Account Debit, Explanation, Folio, Accounts Receivable 
Dr., Cash Sales Dr., Books and Stationery Cr., Sporting Goods and 
Sundries Cr. 

(3) A Cash Receipts Book with column headings from left to right 
as follows: Date, Account Credit, Explanation, Folio, General Ledger 
Cr., Cash Sales Cr., Accounts Receivable Ledger Cr., Sales Discounts 
Dr., Net Cash Received Dr. 

(4) A Cash Disbursements Book with column headings from left 
to right as follows: Date, Account Debit, Explanation, Folio, Gen- 
eral Ledger Dr., Accounts Payable Dr., Purchase Discounts Cr., Net 
Cash Paid Cr, 

(5) A six-column General Journal ruled as follows: the three debit 
money columns headed from left to right; Accounts Receivable 
Ledger, Accounts Payable Ledger, General Ledger. The three credit 
columns to be headed left to right as follows; General Ledger, Ac- 
counts Receivable Ledger, Accounts Payable Ledger. 

In the General Journal write an entry; a debit to the Accounts Re- 
ceivable Controlling Account in the General Ledger debit column 
equal to the total of all customers' account balances, and in the Gen- 
eral Ledger credit column a credit to each customer's account indi- 
vidually. When this entry has been posted to the General Ledger, 
all customers' accounts will be closed and an Accounts Receivable 
Controlling Account will be established in their place, with a single 
debit balance equal to total of all customers' accounts transferred. In 
the back of your Ledger insert a " tab " marked " Accounts Receiv- 
able Ledger " and open the customers' accounts there, four accounts 
to a page. In the same manner write a second journal entry; a debit 
to each of the Accounts Payable individually and a credit to the Ac- 



460 FUNDAMENTALS OF ACCOUNTING 

counts Payable Controlling Account for an amount equal to the sum 
of all creditors' accounts closed. When this entry has been posted to 
the General Ledger, all creditors' accounts will be closed and an Ac- 
counts Payable Controlling Account will be established in their place, 
with a single credit balance equal to the total of all creditors' accounts 
transferred. Directly following the " Accounts Receivable Ledger," 
insert a " tab " marked " Accounts Payable Ledger," and open the 
creditors' accounts there, four to a page. 

After the new journals have been ruled, and the two journal en- 
tries just outlined written, and the subsidiary ledgers established as 
described, enter the following selected transactions: 
October 16, 19 

A purchase of texts, your order No. 250 from the Blue Book Com- 
pany, arrived terms net 30 days, amount $240.00. Sold textbooks in- 
voice No. 100 to the Middlesex Junior College $127.00. Gave the 
Blue Book Company our 6o-day 6 % note in amount of $260.00 pay- 
ment of invoice of October n in full. Gave a 6o-day 6% note to 
Spaulding and Co. in amount of $475.00 payment of their invoice 
October 10 in full. Mr. Andrews requests you to pay the College 
Supply Co. invoice of October 10 in full less the 3% discount. 
October 17 y 19 

. Mr. Andrews instructs you to pay the following invoices: Metro- 
politan Envelope Supply Co., October 8 less 2%; N. Y. Sporting 
Goods Co., invoice of October 3 net and October 13 less 2%; Plain- 
field Oil Co., October 14 net. Purchased stationery, order No. 251, 
from the Metropolitan Envelope Supply Co. amount $68.00 terms 
2/10 n/30. 
October 18, 19 

Sold texts invoice 101 to New Brunswick High School $240.00. 
Sold texts to South River Board of Education invoice 102 in amount 
$i 18.00. Purchased sundry items your order No. 252, from the Col- 
lege Supply Co., amount $119.00 terms 3/10 n/3o. Paid by check 
$12.00 for cleaning store. Received a check from Thomas Haggerty 
for $21.00 payment of his account in full. Received a check for 
$64.00 from the Beck Shoe Co., their account in full to date. Cash 
Sales for the i6th and i?th were (i) $60.00 and (2) $45.00 (enter 
in Cash Receipts Book and Sales Book). 
October 19, 19 

Drew a check $75.00 for Salaries. Received a check from Rutgers 
Athletic Association amount $129.36 full payment invoice October 16. 
Borrowed from the Peoples Bank, discounting a 6o-day note for 
$1500.00. (Enter in General Journal and Cash Receipts Book.) 
October 20, 19 

Cash Sales for iSthand i9thwere (i) $42.00 and (2) $15.00. Sold 
to Johnson and Johnson stationery invoice 103, amount $44.00. Re- 
ceived checks as follows: $16.00 from New Brunswick High School 
invoice October 5 in full; $23.00 from South River Board of Educa- 
tion invoice October 7 in full; $297.92 from South River Athletic As- 



PRACTICE SET 461 

sociation invoice of October 16 in full. Received a credit memo from 
the College Supply Co. $16.00 for merchandise returned. 
October 22, 19 

Sold texts invoice 104 to Middlesex Junior College $94.00. Sold 
athletic equipment to the South River Athletic Association $610.00 
invoice 105. Received a check for $267.54 from the Middlesex Junior 
College their account in full less 2% a special discount which we allow. 
Purchased a new typewriter from the International Business Ma- 
chines Co. $110.00 terms 2/10 n/3O. 
October 23, 19 

Cash Sales for 2oth and 22nd were (i) $84.00 and (2) $38.00, 
Purchased Sporting goods invoice 253, $i 18.00 from N. Y. Sporting 
Goods Co. Issued a credit memo to the South River Athletic Asso- 
ciation $36.00 surplus equipment returned as per agreement. 
October 24, 19 

Purchased texts invoice No. 256 from N. Y. Book Co. amount 
$i 18.00 terms net 30 days. Gave our check $103.21 to N. Y. Book 
Co., to apply $100.00 on note and $3.2 1 interest to date. Sold to the 
Rutgers Athletic Association equipment $285.00 terms 2/10 11/30. 
October 25, 19 

Cash Sales for 23rd and 24th were (i) $49.00 and (2) $52.00. 
Sold stationery to Johnson and Johnson $92.00 invoice No. 107. Re- 
ceived a check $124.46 from the Middlesex Junior College invoice 
October 16 less the discount. Issued a credit memo to the Rutgers 
Athletic Association for equipment returned $54.00. Paid the fol- 
lowing invoices: Merit Book Company, October n net; N. Y. Book 
Co., October 13 net. 
October 26, 19 

Sold invoice 108 to Community Playground, equipment $320.00 
and accepted their note for $320.00 six per cent, sixty days. (En- 
ter invoice in Sales Book and Note in Journal.) Received the fol- 
lowing checks: New Brunswick High School invoice October 18 less 
2% $235.20; South River Board of Education invoice October 18 
less 2% $115.64. The Peoples Bank discounted the note for $320.00 
received from the Community Playground. (Enter in both the Jour- 
nal and the Cash Receipts Book.) Drew a salary check $75.00. Pur- 
chased texts from Merit Book Company Order No, 255 amount 
$120.00 terms net 30 days. 
October 27, IQ 

Cash Sales for 25th and 26th were (i) $64.00 and (2) $55.00. 
Sold stationery $24.00 invoice No. 109 to New Brunswick High 
School. Gave the College Supply Co. our check $100.94 payment 
invoice October i8th less credit memo, and discount. Purchased 
equipment from Spaulding and Co. Order No. 257, amount $720.00. 
October 29, 19 

Received a credit memo, from the Merit Book Company for sur- 
plus texts returned to them $32.00. Also received a credit memo 
from Spaulding and Co. for $16.00, defective equipment returned 



462 FUNDAMENTALS OF ACCOUNTING 

as per agreement. Cash Sales 27th and 28th were (i) $83.00 and 
(2) $25.00. Sold to the Middlesex Junior College practice sets, in- 
voice No. no $35.00 terms net 30 days. Sold to South River Ath- 
letic Association equipment invoice No. in amount $200.00 terms 
2/10 11/30. 
October 30, 19 

Received a shipment of fuel oil from Plainfield Oil Co., our Order 
No. 258, 450 gals, at 6^, terms net 30 days. Cash Sales for 2gih and 
3oth were (i) $30.00 and (2) $55.00. Received a check $43.12 
from Johnson & Johnson payment in full invoice October 20th. Sold 
texts invoice 112 to South River Board of Education $116.00. Sold 
athletic equipment to the New Brunswick High School invoice 113 
amount $115.00 terms 2/10 n/30. 
October 31, ig 

Paid by check Telephone bill to date $16.40. Gave a reimbursing 
check in amount of $21.70 to clerk for petty cash expenditures to 
date. Charge the following accounts : 

General Expense $ 3.20 

Postage 6.00 

Telephone & Telegraph 8.00 

Express 4.50 

$21.70 

Required: 

1 i ) Total all books of original entry. The totals will be checked 
in class. 

(2) Post all the journals. 

(3) Prove the total of all subsidiary ledger account balances of the 
two subsidiary ledgers with their respective controlling ac- 
counts. 

(4) Take a trial balance of the general ledger at October 31. 



INDEX 



Acceptance, Trade 

Defined and explained, 108 

Illustrated, 108 
Account 

Balance type illustrated, 45, 46 

Cash account illustrated, 44 

Defined, 44 

Formally balanced, 48, 49 

Illustrations ruling, 43 

<4 T " ledger account illustrated, 49 
Accounting 

Introduction to, 1-7 

Period, the, 9, 153 
End of, 152 

Plan of text, 6 

Profession, i, 2 

Professional societies, 4 

Related to other business and other 

professions, 5, 6 
Accounts 

Chart of, 56 

Classification, 50 

Real and nominal, 55 
Accounts payable controlling account 

Case study illustrating establish- 
ment of accounts payable 
ledger and controlling account, 

134 
Illustrated and functions of, 135 

Accounts receivable, analysis of ac- 
count, 434 

Controlling account illustrated and 
explained, 133 

Accrued expenses, adjustments for, 188 

Accrued income, adjustment for, 190 

Adjusting and closing books, case il- 
lustration, 195 

Adjusting and closing entries 

Case study complete with work 

sheet, 220 
For a manufacturer, 378 

Adjusting entries, case illustration, 
156 

Adjustments, for merchandise inven- 
tory, 154 

Adjustments and the work sheet, dem- 
onstration exercise, 220 

Analysis of balance sheet, case illus- 
tration, 429, 430 

Analysis of financial statements, acid 
test ratio, 436 

Assets 

Current, 19 



463 



Deferred, 19 
Defined, 10 
Fixed, 19 

Rules for debiting and crediting, 56 
Asset and expense differentiated, 31 

B 
Balance sheet 

Analysis and interpretation, 427 

Comparative balance sheet illus- 
trated, 440 

Current assets, 19 

Current liabilities, 20, 21 

Deferred charges, 19 

Defined, 9 

Differentiated from P & L state- 
ment, 27 

Effect of business transactions on 
the balance sheet, 13-15 

Fixed assets, 19 

Fixed liabilities, 20, 21 

Fundamental equation of, 12 

Illustration, 225 
Corporation, n 
Partnership, n 
Sole proprietorship, 8 

Net worth, 20, 21 

Prepared from work sheet, 201 

Report form of, 17, 18, 20 

Reserves on, 20, 21 

The three elements of, 9 
Balance sheet analysis 

Case illustration, 429, 430 

Working capital, 431 
Balance sheets, classified, 18 
Bill of exchange 

Defined, 94, 107 

Parties to, 107 
Bill of lading, illustrated, 79 
Bond discount, accounting for, 323 
Bond premium, accounting for, 322 
Bookkeeping cycle, the, 152 



Capital 

Defined, 10 

Statement of, 33 
Capital stock 

Call accounts, 289 

Common, defined, 281 

Preferred, 282 

Cash basis, books kept on, 187 
Cash disbursements, rules for han- 
dling, 85 



464 



FUNDAMENTALS OF ACCOUNTING 



Cash disbursements book 

For departmental business, 354 

Illustrated, 355 

Cash receipts, rules for handling, 84 
Cash receipts book for departmental 

business, 351 
Cash receipts journal for departmental 

business, illustrated, 352 
Certified public accountant 

General requirements for, i 

Work of, 2, 3 
Check register for voucher payment, 

399 

Classification of accounts, 50 
Closing entries, case illustration, 161, 

162, 163, 164, 165, 195, 202 
Comparative balance sheet, 437 

Illustrated, 440 
Comparative income statement, 439 

Illustrated, 443 

Contingent liability for notes receiv- 
able discounted, 104 
Controlling accounts 
Accounts receivable controlling ac- 
count defined, 133 
Illustration and functions of, 133 
Advantages of, 145 
Established with accounts receivable 

ledger, 133 
Formation of accounts receivable 

ledger case study, 131 
Practice set for accounts payable, 

142-144 
Practice set for accounts receivable, 

141 

Corporation 
Definition, 276 

Statement of surplus, 310, 311 
Stock dividends, 312 
Corporations 

Accounting for forfeited stock, 289 
Accounts peculiar to the corpora- 
tion, 307 

Advantages of corporate form, 277 
Bond premium and discount, 321 
Bonds 

Accounting for, 319 
General, 315 
Some usual forms, 317 
Sold on installments, 320 
Capital stock types in use, 281 
Dividend accounts, 311 
Dividends, accounting for, 314 
Formation, obtaining charter, 279 
Incorporating a partnership, 297 
Minute book, 303 
No par value stock, 292 
Opening entries, case study, 284 
Organization expense, 324 
Records peculiar to, 303 



Stock certificate book, 303 

Stock ledger, 305 

Stock sold on installments, 285, 288 

Stock subscriptions book, 306 

Stock transfer book, 306 

Surplus and deficit, 309 

Theory of corporations applied, a 
case study, 331-342 

Treasury stock, 294 

Unissued capital stock, 309 
Cost accounting, introduction to, 372 
Cost of goods sold, 29 
Course of study for public accounting, 

4 

Credit memo, illustration, 82 
Credit terms and cash discounts, 82 

D 

Debit and Credit memoranda 

Explained, 81 

Rules for, 56-58; in summary form, 

66 

Deferred expense, adjustment for pre- 
paid items, 192; for supply in- 
ventories, 191 
Deferred income, adjustment for, 194, 

218 

Departmental purchase book illus- 
trated and explained, 348 
Departmental records, reasons for, 346 
Departmental sales book illustrated, 

350 
Depletion, 178 

Adjustment for, 179 
Depreciation 

Accounting for, 170 

Bases for computing, 170 

Case for over-depreciation, 175 

Case illustration, 172, 173 

Defined, 169; explained, 168 

Rates and their determination, 176 

Replacement of assets: insufficient 
depreciation, 174 

Replacements, 178 

Reserves on the balance sheet, 178 

Straight line method, 171 
Discounts 

Cash, 83 

Trade, 83 
Dividends 

Cash, 311 

Declared by board of directors, 313 

Payable in scrip, 311 

Stock dividends, 312 
Double entry explained, 54 
Doubtful accounts 

Accounting for reserve, 181 

Adjustment for, 180, 181 
Draft illustrated, 107 
Drafts, sight and time, 94 



INDEX 



465 



Endorsements. See negotiable instru- 
ments, 98 
Endorser's warranties, 99 

F 

Fair Labor Standards Act (The Wage 

and Hour Law), 415 
Federal old age and survivors 
Covered employment, 412 
Insurance tax, 411 

Federal unemployment act, merit rat- 
ings, 414 
Financial statements 

Prepared from work sheet, 159 
Purpose, 8 

Financial statements analysis, inven- 
tory, 435 

G 

General and administrative expense 
29, 30 

I 

Interest, bankers sixty day method, 
100, 101 

Interest and discount, how calculated, 
100 

Interest earned account, further use 
of, 107 

Interest expense account, further use 
of, 106 

Inventory, " old " and " new " illus- 
trated, 155 

Invoice, sales invoice illustrated, 76 



Journal 

General journal illustrated, 71, 72 

Summary illustration of journaliz- 
ing, 86-89 

Journal entries, source of, 47 
Journals 

Cash disbursements, 120 
With controlling accounts, 140 

Cash receipts, 119; cash balance il- 
lustrated, 121, 122; with con- 
trolling accounts, 136 

Columnar general journal for use 
with controlling accounts, il- 
lustrated, 137 

Entries in two special journals, 
cross checking, 123, 124 

Purchase Journal, 115, 116 

Sales book with controlling ac- 
counts, 135 

Sales Journal, 117, 118 



Ledger defined, 41 
Liabilities 



Current, 20, 21 
Defined, 10 
Fixed, 20, 21 

Liability, rules for debiting and cred- 
iting, 57 

M 

Manufacturing, adjusting and closing 
entries for, 383-386 

Closing books for manufacturing 
co., demonstration case, 379 

Closing entries for a manufacturing 
co., 383 

Cost of goods manufactured ac- 
count, 378 

Profit and loss statement illustra- 
tion, 35 

Summary of closing accounts, 386 

Trading account, the, 379 
Manufacturing accounts, three ele- 
ments of manufacturing costs, 

373 
Manufacturing statements 

Cost of goods manufactured sched- 
ule, 375 

Profit and loss statement for a man- 
ufacturer, 374 

Use of schedules in statements, 374 
Municipal accounting, 3 



N 

Negotiable instrument defined, 93 
Negotiable instruments 

Definition explained, 95 

Endorsements, 98 

Explained, 92 

Note illustrated, 96 

Requirements for, 94 

Terms used with notes, 97 

Types, 93 
Negotiable promissory note defined, 

93 

Net worth 
Defined, 10 

Rules for debiting and crediting, 57 
Nominal accounts, rules for debit and 

credit, 60 

Non-operating expense, 31 
Non-operating income, 31 
Notes 

Accounting for, 101, 102 
Dishonored and protested, 105 
Renewed, 104 
Notes receivable 

Analysis of account, 434 
Contingent liability for discount, 

104 

Notes receivable register, 356; illus- 
trated, 357 



466 



FUNDAMENTALS OF ACCOUNTING 



Operating expenses, 29, 30 



Partnership 

Admission of new partner, 257 
Case illustrations, 258-260 

Articles of co-partnership, 233 

Bases of profit distribution, 240- 
246 

Defined, 232 

Dissolution and termination, 263 

Division of profits, 239 

Formation of, 231 

Forms of business organization com- 
pared, 229-231 

Goodwill in, 261 

Interest on partners' capital, 246 

Limited partnership, 271 

Liquidation of partnership, case il- 
lustration, 266, 268 

Opening journal entries, 234, 236, 

237 

Partners' drawing accounts, 251 
Partners' loan accounts, 252 
Rules for settling accounts after dis- 
solution, 264 

Salaries or division of profits, 248 
Petty cash 

System explained, 85 
Voucher illustrated, 86 
Post closing trial balance, illustrated, 

208 

Practice set, college book shop: unit 
No. i, 451 ; unit No. 2, 455 ; unit 
No. 3, 459 

Prepaid and deferred items, adjust- 
ments for, 216 
Prepaid insurance, adjustments for, 

217, 218 

Profit and loss statements 
By departments, 360 

Illustrated, 362 

Differentiated from balance sheet, 27 
Explained, 27-30 
Illustration, 29, 224 
Net sales on, 28 
Prepared from work sheet, 200 
Purpose, 26 
Profit and loss summary account for 

a manufacturer, 379 
Purchase book, for departmental busi- 
ness, 348 

Purchase order illustrated, 74 
Purchase requisition illustration, 74 
Purchase returns, entry for, 81 
Purchase returns and allowances, ex- 
plained, 79 



R 

Receipts, importance of in business, 78 

Receiving and checking forms illus- 
trated, 75 

Reserve for doubtful accounts, func- 
tion of, 181 

Reversal entries explained and illus- 
trated, 212 



Sales book for departmental business, 

350 

Sales return journal explained, 359 
Sales returns explained, 79 
Sales returns and allowances, entries 

for, 80, 8 1 

Selling expenses, 29, 30 
Social Security 

Employment records, 417 

Identification number for employ- 
ees, 412 

Laws, 410 

Payroll check illustrated, 420 

Payroll forms, 418, 419 

Payroll records, 416 

Record-keeping requirements, 416 
Special journals, introduction to, 115 
State unemployment employers tax, 

414 

State unemployment taxes, 413 
Statement illustrated, 78 
Stock dividends on no-par shares, 312 
Stock transfer control sheet, 307 
Subsidiary ledgers and controlling ac- 
counts, 42 
Surplus, statement of, 34, 35 



Tax consultant, 3 
Transactions 

Analyzed, 58, 62, 63 

Posted, 59-6o, 63-65 
Trial balance 

Explained, 47 

Illustrated, 60, 66 

Post closing, 165 
Trial balance book, 48 

U 

Uniform negotiable instruments law, 
92 



Voucher 

Checks illustrated, 398 

Defined, 391 

Voucher jacket illustrated, 393 
Voucher register 



INDEX 



467 



Explained, 394 

Illustration, 395, 403, 404 

Summer posting at end of period, 

396 
Voucher system 

Accounting for partial payment of 
voucher, 401; for notes pay- 
able, 401 ; for returns and al- 
lowances, 400 

Advantages of, 406 



Filing the vouchers, 397 

Journal voucher, 405 

Vouchers payable controlling ao 

count, 402 
Vouchers requiring immediate pay 

ment, 399 

W 

Work Sheet explained, 159, 197, 382 
Illustrations, 158, 197, 221, 380, 381